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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended December 31, 2002

Commission file number 1-4373



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|                                                                              
|------------------------------------------------------------------------------
|THREE-FIVE SYSTEMS, INC.(Exact Name of Registrant as Specified in Its Charter)

|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 86-0654102                          
|                                                               |  |                                     
|(State or Other Jurisdiction
of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)

|                                         |  |  |  |           
|---------------------------------------- |  |  |  | ----------
|1600 North Desert Drive, Tempe, Arizona  |  |  |  | 85281     
|                                        
|(Address of Principal Executive Offices) |  |  |  | (Zip Code)

|                                                                   
|-------------------------------------------------------------------
|(602) 389-8600
(Registrants telephone number, including area code)

Securities regisered pursuant to Section 12(b) of the Exchange Act:

|                                                                       |  |                                                
|---------------------------------------------------------------------- |  | -----------------------------------------------
|Title of Each Class                                                    |  | Name of Each Exchange on Which Registered      
|                                                                       |  |                                                
|Common Stock, par value $.01 per share
Preferred Stock Purchase Rights |  | New York Stock Exchange
New York Stock Exchange

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [   ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [   ]

The aggregate market value of Common Stock held by nonaffiliates of the
registrant (18,004,680 shares) based on the closing price of the registrants
Common Stock as reported on the New York Stock Exchange on June 28, 2002, was
$205,253,352. For purposes of this computation, all officers, directors, and
10% beneficial owners of the registrant are deemed to be affiliates. Such
determination should not be deemed to be an admission that such officers,
directors, or 10% beneficial owners are, in fact, affiliates of the registrant.

As of March 21, 2003, there were outstanding 21,286,039 shares of the
registrants Common Stock, par value $.01 per share.

Documents Incorporated by Reference

Portions of the registrants definitive Proxy Statement for the 2003
Annual Meeting of Stockholders are incorporated by reference into Part III of
this Form 10-K.





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TABLE OF CONTENTS



|                                           |                                                                                                                              |  |  |  |  |  |  | 
|------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                    
|                                           | ITEM 1. BUSINESS                                                                                                            
|                                           | ITEM 2. PROPERTIES                                                                                                          
|                                           | ITEM 3. LEGAL PROCEEDINGS                                                                                                   
|                                           | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                 
|PART II                                   
|                                           | ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                                               
|                                           | ITEM 6. SELECTED FINANCIAL DATA                                                                                             
|                                           | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                               
|                                           | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                         
|                                           | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                         
|                                           | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND                      FINANCIAL DISCLOSURE           
|PART III                                  
|                                           | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                                 
|                                           | ITEM 11. EXECUTIVE COMPENSATION                                                                                             
|                                           | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND                      RELATED STOCKHOLDER MATTERS
|                                           | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                     
|                                           | ITEM 14. CONTROLS AND PROCEDURES                                                                                            
|PART IV                                   
|                                           | ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                                                   
|SIGNATURES                                
|CERTIFICATION OF CHIEF EXECUTIVE OFFICER  
|CERTIFICATION OF CHIEF FINANCIAL OFFICER  
|INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
|Index to Exhibits                         
|EX-4.1                                    
|EX-10.3                                   
|EX-10.4                                   
|EX-10.6                                   
|EX-10.8                                   
|EX-10.13                                  
|EX-10.15                                  
|EX-10.16                                  
|EX-10.17                                  
|EX-21                                     
|EX-23.1                                   
|EX-23.2                                   
|EX-99.1                                   
|EX-99.2                                   



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##### Table of Contents



THREE-FIVE SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2002

TABLE OF CONTENTS

PART I

|                                           |  |                                                                                                |     |  |    | 
|------------------------------------------ |  | ---------------------------------------------------------------------------------------------- | --- |  | -- | 
|ITEM 1.                                    |  | BUSINESS                                                                                       |     |  | 1  | 
|ITEM 2.                                    |  | PROPERTIES                                                                                     |     |  | 37 | 
|ITEM 3.                                    |  | LEGAL PROCEEDINGS                                                                              |     |  | 38 | 
|ITEM 4.                                    |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                            |     |  | 38 | 
|PART II                                   
|ITEM 5.                                    |  | MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS                          |     |  | 38 | 
|ITEM 6.                                    |  | SELECTED FINANCIAL DATA                                                                        |     |  | 39 | 
|ITEM 7.                                    |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS          |     |  | 39 | 
|ITEM 7A                                    |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                     |     |  | 50 | 
|ITEM 8.                                    |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                    |     |  | 51 | 
|ITEM 9.                                    |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE           |     |  | 51 | 
|PART III                                  
|ITEM 10.                                   |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                             |     |  | 51 | 
|ITEM 11.                                   |  | EXECUTIVE COMPENSATION                                                                         |     |  | 51 | 
|ITEM 12.                                   |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS |     |  | 51 | 
|ITEM 13.                                   |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                 |     |  | 51 | 
|ITEM 14.                                   |  | CONTROLS AND PROCEDURES                                                                        |     |  | 51 | 
|PART IV                                   
|ITEM 15.                                   |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                               |     |  | 52 | 
|SIGNATURES                                 |  |                                                                                                | 54  | 
|CERTIFICATIONS                             |  |                                                                                                | 55  | 
|INDEX TO CONSOLIDATED FINANCIAL STATEMENTS |  |                                                                                                | F-1 | 

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Statement Regarding Forward-Looking Statements

The statements contained in this report on Form 10-K that are not purely
historical are forward-looking statements within the meaning of applicable
securities laws. Forward-looking statements include statements regarding our
expectations, anticipation, intentions, beliefs, or strategies
regarding the future. Forward-looking statements also include statements
regarding revenue, margins, expenses, and earnings analysis for fiscal 2003 and
thereafter; technological innovations; future products or product development;
our product development strategies; potential acquisitions or strategic
alliances; the success of particular product or marketing programs; the amounts
of revenue generated as a result of sales to significant customers; and
liquidity and anticipated cash needs and availability. All forward-looking
statements included in this report are based on information available to us as
of the filing date of this report, and we assume no obligation to update any
such forward-looking statements. Our actual results could differ materially
from the forward-looking statements. Among the factors that could cause actual
results to differ materially are the factors discussed in Item 1, Business 
Risk Factors.

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PART I




ITEM 1. BUSINESS

Introduction

We design and manufacture display modules and display system solutions,
develop and manufacture microdisplays, and provide electronic manufacturing
services for original equipment manufacturers, or OEMs. Through our Integrated
Systems and Display, or ISD, division, we offer a broad range of custom and
standard display products and product solutions, including monochrome and color
liquid crystal display, or LCD, components and modules, organic light emitting
diodes, or OLEDs, cathode ray tubes, or CRTs, and flat panel monitors for use
in the end products of OEMs. Our LCD modules are used in mobile handsets and
other wireless communication devices as well as in the data collection, medical
electronics, and other commercial, consumer, and industrial marketplaces.
Through this division, we also offer electronic manufacturing services to OEMs,
which include advanced engineering support, designed for services, automated
printed circuit board assembly, in-circuit and functional testing, systems
level integration and box build, turn-key packaging, fulfillment services, and
turn-key supply chain management services, all of which enable our customers
the ability to outsource all stages of product engineering, design,
development, materials procurement and management, manufacturing, and testing.
Through our Microdisplay division, we offer discrete microdisplay devices
through completely integrated microdisplay engine solutions based on our liquid
crystal on silicon, or LCoS®, microdisplay technology. Examples of
applications for our microdisplay products and services include rear-projector,
high-definition, televisions; front-projector multimedia and home theater
projectors; and near-to-eye or personal display applications, including
head-mounted monocular or binocular headsets or viewers for industrial,
medical, military, commercial, and consumer applications. We market our
services in North America, Europe, and Asia through a direct and representative
technical sales force.

We recently announced that our board of directors has approved a decision
to spin-off our Microdisplay division into a newly created and separately
traded public company to be known as Three-Five Microdisplay, Inc., or TFMD.
We expect that the proposed spin-off will allow each company to focus its
attention and financial resources on its target markets. In addition, each
company will be able to more aggressively pursue its distinct business model
and better meet the needs of its customers. The transaction is also expected
to provide each independent company with greater strategic and financial
flexibility to support growth opportunities in the future. Under the proposed
spin-off, we will first transfer our entire LCoSmicrodisplay business,
including all related manufacturing and business assets, personnel, and
intellectual property, to TFMD, a newly created subsidiary. Included in the
transfer will be established manufacturing infrastructure, such as quality,
logistics, planning, and procurement systems. We then expect to capitalize
TFMD with approximately $20 to $25 million in cash, an amount that we believe
will be sufficient to enable TFMD to achieve its business objectives. We will
then distribute 100% of TFMDs common stock pro rata as a dividend to our
stockholders. We have filed a ruling request with the Internal Revenue Service
to qualify the spin-off of TFMD as a nontaxable transaction. In addition, we
expect to file a Form 10 with the Securities and Exchange Commission within the
next 60 days providing detailed information regarding the proposed spin-off.
No stockholder vote will be required to effect the spin-off, and no
consideration will be required to be paid by our stockholders in order to
receive the stock of TFMD.

Our website is located at www.threefive.com. Through our website, we make
available free of charge our annual report on Form 10-K, our proxy statement,
our quarterly reports on Form 10-Q, our current reports on Form 8-K, amendments
to reports filed under the Securities Exchange Act, and earnings press
releases. We also post on our website the charters of our Audit, Compensation,
and Nominating/Corporate Governance Committees; our various codes of ethics and
any amendments of or waiver to those codes of ethics; and any other corporate
governance materials contemplated by SEC and NYSE regulations.

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Industry Overview

Displays

Display Technology

Prior to the 1970s, most commonly used displays and indicators had
substantial limitations as to their use, especially in terms of size, life, and
power consumption. LCDs were developed in the 1970s in response to these
limitations, especially the demand for greater information content and less
power consumption than was possible using light emitting diode, or LED,
technology. LCDs, sometimes called flat panel displays, provide
high-information content displays at competitive prices. LCDs now appear in
products throughout the communications, office automation, industrial, medical,
and commercial electronics industries. LCDs are one of the fastest growing of
the established display industry segments.

An LCD modifies light that passes through or is reflected by it, rather
than emitting light like an LED. An LCD generally consists of a layer of
liquid crystalline material suspended between two glass plates. The liquid
crystals align themselves in a predictable manner when stimulated electrically.
The alignment produces a visual representation of the desired information.
LCDs can display information in black and white or in a wide range of color
combinations. LCD displays consist of a matrix of dots, called pixels, which
are arranged in rows and columns that can be selectively energized to form
letters or pictures. A principal advantage of LCDs over other display
technologies, such as LEDs, is the ability to include thousands or even
millions of pixels in a single display, which allows for greater information
content.

There are two types of LCDs: active matrix and passive matrix. Active
matrix LCD displays are relatively complex devices that require manufacturing
operations involving very large capital investments. Historically, active
matrix LCD displays have been used in larger, high-information content
applications, such as laptop computers, but they are becoming more common in
mobile devices, such as cellular handsets and PDAs. Passive matrix LCD
displays are less complex and less expensive to manufacture. Currently,
passive matrix LCDs are used in applications such as mobile handsets and PDAs,
as well as in office equipment, data collection terminals, point-of-sale
equipment, medical devices, transportation instrumentation, and industrial
instruments and controls.

An LCD is primarily a reflective type of display. Other display
technologies are also available. Recent progress in the development of organic
electro-luminescent materials has revived interest in organic light-emitting
diodes, or OLEDs. Two classes of electro-luminescent materials have been used
in OLED development: small molecules and light-emitting polymers. The
advantages promised by OLED technology include the ability to have thin,
light-weight displays with low voltage, low power, a wide viewing angle, and a
broad color gamut. OLEDs have only recently begun to be manufactured, but
there is strong industry interest in OLEDs and a significant level of industry
investment in the development of this technology.

Display Markets

Displays are becoming a ubiquitous feature in consumer, commercial, and
industrial products. OEMs increasingly believe that a display interface is
important because it makes products more useful and easier to operate. In
addition, the increasing complexity and functionality of handheld products,
such as wireless computing and communication devices, require OEMs to increase
the visual performance and information content of the displays incorporated
into their products. At the same time, the market continues to demand that
OEMs incorporate displays with reduced power requirements and lower costs.
Custom LCDs, including both monochrome and color displays, address these
requirements for high performance, increased information content, low power,
and low cost. In addition, OLED displays are making advances in technology
development, cost reduction, and power consumption and are beginning to be used
in mobile and other applications.

OEMs also seek ways to differentiate their products from the products of
their competitors. Custom-designed display modules provide OEMs a
cost-effective means to achieve this differentiation. In designing its
product, an OEM must determine whether to use standard off-the-shelf display
modules, to design its own custom display modules for production by a custom
display manufacturer, or to enter into arrangements with a third party for
custom display design and production. In making a decision to engage third
parties for custom design and production, OEMs recognize that standard
off-the-shelf displays may be more cost-effective, but make it more

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difficult to differentiate their products from those of their competitors.
In considering whether to design their own display modules, OEMs often
recognize that their greatest strengths consist of consumer brand name
recognition, market research and product development expertise, and highly
developed sales and distribution channels. Advanced design and manufacturing
processes require increasing investments for research and development,
personnel, and equipment. Competitive market conditions require a shorter
period of time from product conception to delivery, product differentiation,
improved product user friendliness, and continually enhanced product
performance and reduced product cost during the life cycle of the product. As
a result of these factors and increasingly sophisticated and complex
technology, it has become more difficult for even the leading OEMs to maintain
the necessary technology, expertise, personnel, and equipment to design and
produce internally all of the various components necessary for their products.
As a result, there has been a trend toward outsourcing the design and
production of components such as display modules.

In addition to design and production, OEMs have increased their use of
third-party suppliers to add additional components to their products. This
permits the integration of more of the manufacturing steps into fewer
locations. This trend toward integration and outsourcing decreases the number
of suppliers necessary to produce a final product and results in lower costs.
We believe that combining the display module with other manufacturing services
could be a key differentiator.

The products that we sell include both standard and custom displays.
Applications include displays used in mobile handsets and other communications
equipment; business, industrial, and transportation equipment; and computer,
consumer, and industrial products. The display technologies that we focus on
are LCDs, OLEDs, and CRTs. Historically, our emphasis was on small form factor
displays, but we recently acquired a monitor product line with displays ranging
up to 21 inches for use in industrial and governmental applications. We
estimate that the world-wide market we service for display products was
approximately $12 billion in 2002.

Electronic Manufacturing Services

Historically, OEMs have been fully integrated, performing the engineering
and design, new product introduction, assembly and manufacturing, testing,
distribution and logistics, and aftermarket support functions for their
products. In recent years, however, OEMs have been under intense pressure to
reduce costs, focus on core competencies, and reduce supply chain investment.
In response, they have increasingly outsourced these functions to electronic
manufacturing services, or EMS, companies. By focusing on these functions, we
believe that EMS companies have provided OEMs with cost savings, superior
technological know-how, and access to more advanced manufacturing processes.
These services enable OEMs to concentrate on their core competencies, such as
product development, marketing, and sales. As a result of this outsourcing
strategy, many OEMs are divesting a significant portion of their manufacturing
facilities, and many newer OEMs are choosing to outsource rather than build an
internal manufacturing infrastructure.

Today, the EMS industry consists of companies that provide a broad range
of services, including engineering and design, new product introduction,
printed circuit board assembly, or PCBA, box build, testing, distribution and
logistics, and aftermarket support services for OEMs in the electronics
industry. The penetration of EMS companies into the total available market
remains low. Technology Forecasters, Inc. estimates that the total cost of
goods sold outsourced by OEMs will grow from 18.9% in 2002 to an estimated
24.4% by 2005. As a result, Technology Forecasters, Inc. estimates the EMS
industry will grow at 16.6% comparable annually from approximately $92 billion
in 2002 to $139 billion in 2005. The trend toward outsourcing by OEMs has
continued in the recent economic downturn, as OEMs are under increased pressure
to pursue aggressive cost savings.

In addition, OEMs have continued to move manufacturing programs to lower
cost regions and sought EMS providers with a global footprint. As a result,
Asias share of the global EMS market, as reported by Technology Forecasters,
Inc., is estimated to increase from 29% in 2002 to 42% in 2006. We also
believe that EMS providers with a global presence will grow faster than the
industry average because they can offer multinational OEMs a comprehensive set
of outsourced services through a single global manufacturing platform.

The factors driving OEMs to favor an outsourcing strategy include the
following:



| |  |  | Reduced Total Production Cost. OEMs must continually reduce
costs to remain competitive. EMS companies can manufacture products
at a reduced total cost to OEMs because of higher utilization of
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |   |  | manufacturing capacity, access to leading-edge manufacturing
technologies, superior procurement and inventory management
capabilities, and a continual focus on improving supply chain
management practices from product design to aftermarket support.                                                                                                                                                                                                                                                                                                                                                           
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Ability to Focus on Core Competencies. By shifting design,
manufacturing, testing, logistics and distribution, and aftermarket
support functions to EMS companies, OEMs can focus their resources
on their core competencies, including product development,
marketing, and sales.                                                                                                                                                                                                                                                                                                                                
|
| |  |  | Access to Leading Technologies. OEMs continually seek access
to engineering expertise and manufacturing technologies necessary to
build their increasingly complex products. OEMs are motivated to
work with EMS companies to gain access to their expertise in product
design, assembly, manufacturing, and testing technologies, as well
as their expertise in global supply chain management and aftermarket
support. In addition, EMS companies provide OEMs with access to
advanced information systems, enabling OEMs to better monitor and
control the global inventory and distribution of their products.
|
| |  |  | Reduced Supply Chain Investment. Outsourcing to EMS
companies allows OEMs to lower their investment in inventory and
manufacturing assets and shift more of their fixed costs to variable
costs, enabling them to increase their return on assets. As a
result, OEMs can react more quickly to changing market conditions
and allocate capital to other core activities.                                                                                                                                                                                                                                          
|
| |  |  | Accelerated Time-to-Market and Time-to-Global Volume. By
using EMS companies with capabilities in major global markets, OEMs
can expand sales and simultaneously introduce new products
worldwide. Once products have been developed, OEMs must quickly
reach commercial volume production and distribute their products in
all major markets in order to achieve the greatest impact in a
competitive market.                                                                                                                                                                                                    

Microdisplays

Industry Background

Market trends demand high-information content, power-efficient displays
with increasing functionality and smaller sizes at low costs. Microdisplays
provide a response to those demands. Microdisplays are thumbnail sized, but
deliver high-resolution images, including full motion video and computer screen
content. The tiny image on a microdisplay is projected onto a screen or other
surface for individual or group viewing or is viewed through a magnifying
device similar to a viewfinder in portable applications.

As a result, microdisplays are increasingly used in a wide array of
products in established and developing markets. These products include rear
projectors, such as large-screen televisions; multimedia front projectors, such
as those used in conference room and home theater settings; and various
near-to-eye industrial, medical, military, commercial, and consumer
applications.

Rear-projection televisions shine a magnified image onto the back of a
translucent screen for viewing; multimedia front projectors cast the image
produced by a microdisplay on a distant screen; and near-to-eye microdisplay
devices produce a virtual image that can be viewed through a magnifying headset
or viewer.

Display Resolution Standards

The following table sets forth various standard resolutions with pixel
count, or the number of dots on a screen, and applications for liquid crystal
on silicon microdisplays:

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|                                         |  |             |  |             |  |                                                                                                                                                         
|---------------------------------------- |  | ----------- |  | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------
|                                         |  |             |  | Total       |  |                                                                                                                                                         
|Resolution                               |  | Pixel Array |  | Pixel Count |  | Applications                                                                                                                                            
|                                         |  |             |  |             |  |                                                                                                                                                         
|                                         |  |             |  |             |  |                                                                                                                                                         
|Computer and hand-held device standards:
|                                         |  |             |  |             |  |                                                                                                                                                         
|QVGA                                     |  | 320x240     |  | 76,800      |  | Low-resolution standard, primarily used today
in viewfinders for camcorders, digital cameras,
low-end hand-held video games, and other
consumer products
|                                         |  |             |  |             |  |                                                                                                                                                         
|SVGA                                     |  | 800x600     |  | 480,000     |  | Viewfinders in hand-held devices and
head-mounted displays                                                                                              
|                                         |  |             |  |             |  |                                                                                                                                                         
|XGA                                      |  | 1024x768    |  | 786,432     |  | Portable audio-visual projectors and television
applications                                                                                            
|                                         |  |             |  |             |  |                                                                                                                                                         
|SXGA                                     |  | 1280x1024   |  | 1,310,720   |  | High-end portable audio-visual projectors,
rear-projection monitors                                                                                     
|                                         |  |             |  |             |  |                                                                                                                                                         
|UXGA                                     |  | 1600x1200   |  | 1,920,000   |  | High-end notebook computers used for multimedia
applications and high-end computer monitors                                                             
|                                         |  |             |  |             |  |                                                                                                                                                         
|WUXGA                                    |  | 1900x1200   |  | 2,280,000   |  | High-end computer monitors and multimedia
applications                                                                                                  
|                                         |  |             |  |             |  |                                                                                                                                                         
|Television Standards:                   
|                                         |  |             |  |             |  |                                                                                                                                                         
|NTSC                                     |  | 640x480     |  | 307,200     |  | Current most commonly used television standard                                                                                                          
|                                         |  |             |  |             |  |                                                                                                                                                         
|HDTV1                                    |  | 1280x720    |  | 921,600     |  | Partial high-definition digital television and
imaging applications                                                                                     
|                                         |  |             |  |             |  |                                                                                                                                                         
|HDTV2                                    |  | 1920x1080   |  | 2,073,600   |  | Full high-definition digital television and
other high-end imaging applications                                                                         

Rear-Projector Applications

The rear-projector market consists primarily of televisions. Substantial
growth is anticipated for microdisplays in large-screen, high-resolution
televisions and also in new types of large-screen monitors.

One of the primary drivers in the television market is the conversion to
high-definition television, or HDTV. Until now, HDTV has been very slow to
emerge, despite government-mandated broadcasting of HDTV resolution, because
HDTV sets have been unavailable at costs acceptable to the broad consumer
market. It now appears that rear-projection, high-definition televisions using
microdisplays will become the primary avenue for delivering large-screen,
high-definition televisions at reasonable costs. For smaller screen sizes, it
appears that AMLCD-based televisions will become important in the HDTV market.

Another primary driver in the television market is the worldwide
conversion from analog to digital format. This conversion also is being
mandated in the United States, Europe, and Asia by governments and government
agencies. For example, in the United States, the FCC has mandated that all
television transmissions be digital by 2005. The result is that analog
televisions that are digital ready are quickly gaining market share over
analog-only televisions.

Within the home electronics market, there is a continuing trend toward
larger and higher-resolution video screens for home entertainment systems.
These systems are segmented into three categories: high-end home theater;
large-screen, rear-projection television; and smaller-screen, direct-view
television. Each of these segments is growing rapidly. Consumers are willing
to spend more for higher quality entertainment in their homes to support their
diverse television, video, Internet, and other digital entertainment needs.

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Front-Projector Applications

The front-projector market is a large, well-developed market, with an
estimated 1.75 million units shipped worldwide in 2002 and a projected 4
million units to be shipped in 2005. These products, which are typically
referred to as audio-visual or multimedia projectors, are generally fixed or
portable products used in business applications. There is a trend to
developing front projectors that have higher brightness, higher resolution, and
reduced size and cost. Concurrently with the movement to large-screen,
high-definition televisions is an expansion of the front-projector market to
include home theater applications. A new generation of higher resolution front
projectors will be required for full HDTV2.

Near-to-Eye Applications

The near-to-eye market for microdisplays consists of an established
electronic viewfinder market and an emerging high-resolution viewer market.
The established market is served by high-volume, low-cost monochrome and color
microdisplay viewfinder products, nearly all of which are integrated into
camcorders and digital cameras. These viewfinder products are low-resolution
devices, typically QVGA.

In the emerging high-resolution near-to-eye markets, professional
applications in the industrial, medical, and military markets have been the
first to develop. These markets demand superior image quality and high
resolution for image, video, and multimedia applications. Wearable computing,
endoscopic surgery, augmented reality systems, and riflescope applications are
examples of product categories in this segment. Examples of products emerging
in professional and commercial applications include wearable products for
enterprise network access, headmounted displays for night vision systems, and
viewers for test and measurement systems. As prices for near-to-eye
high-resolution microdisplays decline, professional and commercial applications
are expected to broaden.

The consumer market is expected to be by far the largest unit volume
microdisplay market. Anticipated initial applications include headmounted
display products for video games, portable DVD viewers, and secondary monitors
for privately viewing notebook computers. Headmounted microdisplays provide
features that are unavailable in current video game products. These features
include head tracking and stereo and 3-D vision, which provide superior game
immersion and realism. Products currently offered in the headmounted video
game market have low resolution and have experienced limited market success.
By contrast, liquid crystal on silicon microdisplays offer high resolution and
a much improved video game experience.

The broadband wireless communications market also presents a large
opportunity for microdisplays. In the communications market, microdisplay
technology is seen as the potential method for delivering high-information
content at low cost and with low power consumption for mobile, hand-held
communication devices. Timing of the development of the broadband wireless
near-to-eye microdisplay market is uncertain and has been curtailed by the
limited availability and the high price of broadband wireless services.
Nevertheless, many companies have prototype programs underway to assess the use
of liquid crystal on silicon microdisplays for portable wireless devices.

Limitations of Competing Technologies

Currently, the large-screen, rear-projection television market is being
served primarily by incumbent cathode ray tube, or CRT, technology as well as
by emerging active matrix polysilicon and digital micro-mirror device, or DMD,
technologies. CRTs used in rear-projection televisions utilize three
projection devices to create a full motion, full color image. Projection CRTs
present resolution, size, weight, cost, and performance issues. Polysilicon
microdisplays use a transmissive silicon-based technology. Polysilicon
microdisplays are available only from two large Japanese companies. At
resolutions above XGA, polysilicon microdisplays generally need special optics
and are large and expensive. In addition, the transmissive nature of
polysilicon produces an undesirable

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screen door effect on the image. DMD microdisplays, which also are
silicon based, are reflective devices containing an array of individually
movable micro-mirrors, one for each pixel. DMD microdisplays are a proprietary
product of Texas Instruments. DMDs are relatively expensive to manufacture,
especially for larger devices with higher resolutions, and the manufacturing
facilities involve major capital investments. In addition, DMD microdisplays
have image quality issues, particularly related to color depth and video image
fidelity.

Most front projectors currently use either transmissive polysilicon or DMD
microdisplays. Use of polysilicon and DMD technologies in the front-projector
market has the same limitations as in the rear-projection market. As higher
resolution images are demanded by the front-projector market, the limitations
of polysilicon and DMD become more severe. Neither polysilicon nor DMD
technology is likely to achieve full HDTV2 resolutions at reasonable cost.

Direct-view displays currently are the primary means of providing
information content in portable devices. Delivery of high-information content
through a small, direct-view display in a portable device, however, presents
difficult technological challenges and human interface issues. As portable
products become smaller, their direct-view displays also become smaller,
limiting the information content and visual experience offered. Small
direct-view displays can offer limited types of data, often involve cumbersome
navigation, and usually present information only in black and white. Even if
these small displays could present more information content, the user would not
have the ability to read the small images, reducing the usefulness of such a
display. Larger direct-view displays that can present more information and
full-screen content, color, and motion consume battery power quickly, do not
offer superior image quality, and are relatively costly.

The only available microdisplay technologies targeting portable
near-to-eye applications are polysilicon and other transmissive silicon
technologies, OLED on silicon, and liquid crystal on silicon. Polysilicon and
other transmissive silicon technologies have been unable to deliver resolutions
at or above SVGA on a cost-effective basis. OLED on silicon is an immature
technology with issues related to lifetime, cost, manufacturability, and image
quality.

Liquid Crystal on Silicon Microdisplays

An increasing number of OEMs are evaluating liquid crystal on silicon
microdisplays as an alternative to existing technologies in the projector and
near-to-eye markets. In the projector markets, liquid crystal on silicon
technology offers significant advantages in terms of resolution, image quality,
size, and cost, particularly in larger screen sizes, over CRT, polysilicon, and
DMD technologies. For high-resolution color near-to-eye applications, liquid
crystal on silicon microdisplays appear to be the only commercially available
solution.

Today, we and several Japanese OEMs are the only significant liquid
crystal on silicon microdisplay providers. The market participation of these
large Japanese OEMs, which are incorporating liquid crystal on silicon
technology in their own high-end products, is expected to spur the market
penetration of liquid crystal on silicon microdisplays. Chinese, Taiwanese,
and other non-Japanese manufacturers can be expected to consider sources other
than the Japanese OEMs, such as us, for liquid crystal on silicon products.

Stanford Resources projects that the worldwide market for microdisplay
components will increase from $688 million in 2001 to $1.9 billion in 2007, a
compounded annual growth rate of 19%, with more than 44 million units projected
to be shipped in 2007.

Strategy

Integrated Systems and Display (ISD) Strategy

Our objective in our ISD division is to establish a global electronic
manufacturing and engineering organization that supports our position as a
global supplier of display solutions and electronic manufacturing services. In
both instances, we are focusing on providing both our display products and
manufacturing services to OEMs in high-growth segments of the electronics
industry. Key elements of our strategy to achieve these objectives include the
following:

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Target Strong Customers in High-Growth Industries

We identify and target markets that we believe have the greatest long-term
potential for growth. We recognize that our growth and development is closely
aligned with the growth and development of the markets we serve. Our display
modules and solutions are targeted towards wireless communication, data
collection, office automation, medical equipment, and other commercial,
consumer, and industrial marketplace products. Our electronic manufacturing
services business targets the automotive, computer/server, medical monitoring,
and Internet security markets. Our broad range of products and services
enables us to benefit from cross-marketing on a global and market segment
basis.

Within each industry, we target companies that we believe would benefit
from our design and manufacturing services. Targeted customers include
mid-level manufacturing companies whose products require display devices and/or
advanced turn-key manufacturing services. Our sales and engineering staffs
then attempt to demonstrate the benefits that the potential customer would
derive by outsourcing to us the design and production of their products.

Once we establish a relationship with a new customer, we endeavor to
develop new programs for other product groups within the customers business.
For this reason, we specifically target customers with multiple divisions or
product lines.

Establish Close Relationships with Customers

We seek to establish strong and long-lasting customer relationships
through our fundamental business practice, which we refer to as customer
partnering. Customer partnering involves aligning our prospects with those of
our customers and seeking to make our engineering and production staffs
seamless extensions of the product design and production departments of our
customers. This includes our engineers spending a significant portion of their
time assisting customers with their own engineering efforts at their
facilities. In addition, our customers engineers sometimes spend time in our
facilities.

We stress complete product life-cycle solutions to our customers beginning
with early involvement in their product engineering, design, and new product
introduction cycles and continuing through manufacturing, testing, logistics
and distribution, and aftermarket support services. We view each customers
new product as our own and take pride in creating and implementing innovative
engineering solutions that differentiate the customers product from
competitive products. In connection with this philosophy, we have positioned
ourselves to provide a rapid response to our customers and their worldwide
operations.

To achieve our customer partnering goal, we emphasize corporate
cultures, customs, and communications that complement those of our customers.
A thorough understanding of our customers products and business goals enables
us to anticipate customer needs and to develop new design and production
solutions for their products. We embrace diversity as a key element in
strengthening our customer relationships.

We continually attempt to enhance the competitive position of our
customers by providing them with innovative, distinctive, and high-quality
display products and EMS services on a timely and cost-effective basis. To do
so, we work continually to improve our productivity, lower our costs, and speed
the delivery of our product solutions. We endeavor to streamline the entire
design through delivery process by maintaining an ongoing engineering and
manufacturing improvement effort.

We continue to provide customer support after product design has been
completed and production has been commenced. Through such follow-on activity,
we conduct quality enhancement and cost-reduction efforts to maintain the
competitiveness of our customers products.

We intend to continue our efforts to expand our customer base and to
provide our customers with additional services. We actively pursue new
customers, particularly those in growing and emerging markets that have both
volume requirements and require complex solutions. We also evaluate the
requirements of our customers and seek to provide them with additional
services.

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Provide Advanced Custom Design and Manufacturing Services

We seek to design, prototype, and manufacture, on a timely and
cost-effective basis, a wide range of innovative, distinctive, and high-quality
products, including display modules for operational control and information
display functions required in the end products of OEMs. Our design processes
utilize world class technology and business processes to provide custom or
semi-standard solutions for customers products in time frames and on cost
bases that we believe are substantially shorter and competitive with industry
norms. Our market position and insight enables us to continuously develop
unique and difficult-to-replicate solutions.

Until the end of the third quarter of 2001, we operated a highly
automated, high-volume LCD manufacturing line in Arizona to produce the
majority of our LCDs. In order to enhance cost-effectiveness and take
advantage of lower cost manufacturing environments, in the second quarter of
2002, we agreed to sell the manufacturing equipment of our front-end LCD line
and entered into a supply agreement with the buyer under which we purchase our
LCD glass on a favorable price basis with flexible but assured manufacturing
capacity. In addition, we have entered into relationships with manufacturers
of color LCDs. Under these relationships, we will custom design the color LCD
screens for our customers unique applications and then outsource the
manufacture of these screens. We continue to perform back-end and module
manufacturing for those and other products. We utilize advanced, flexible
manufacturing systems for high-volume module assembly in Manila and Beijing.
We believe our manufacturing facilities provide us with a competitive advantage
in meeting the needs of our customers. We will continue to explore the most
advanced and cost-efficient production methods for each product solution.

With the purchase of ETMA Corporation in December 2002, we substantially
increased our ability to provide electronic manufacturing services from our
domestic and Asian facilities, whether or not the products include a display
component. This acquisition provides us with global end-to-end electronic
manufacturing solutions for our OEM customers.

Exceed Customer Requirements through Speed and Efficiency

We emphasize innovative design and manufacturing techniques to improve the
speed, efficiency, and performance of our design and manufacturing services.
This enables our customers to address the pressure to reduce the lead times for
market introduction of their products. As part of our development process, we
continually improve and modify our design and manufacturing processes,
controls, and methodology in an effort to support our customers requirements.

Leverage Research and Engineering

We continually strive to research new technologies and utilize
technologies of our strategic partners and suppliers in order to provide
services and practical product solutions for our customers. We also conduct an
active research and development program designed to



| |  |  | continually improve our products and services and create new products and services;     
| | - |  | ----------------------------------------------------------------------------------------
|
| |  |  | increase our efficiency;                                                                
|
| |  |  | reduce our costs;                                                                       
|
| |  |  | improve the speed, efficiency, and performance of our design and manufacturing services;
|
| |  |  | develop new design and manufacturing processes and techniques; and                      
|
| |  |  | enhance the quality, cost-effectiveness, and value of our services.                     

Pursue Strategic Acquisitions and Alliances

We intend to pursue strategic acquisitions, including OEM manufacturing
divestitures, and alliances to expand our customer base, to expand our product
and service offerings and geographic presence, to address new markets, to
enhance our technological capabilities, or to participate in other growth
opportunities.

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LCoSMicrodisplay Strategy

Provide Value-Added Customer Services

We plan to foster strong and long-lasting customer relationships by
providing customers with the most advanced microdisplays for their products.
We strive to establish strong and long-lasting customer relationships through
customer partnering. This process involves making our engineering and
production staffs seamless extensions of the product design and production
departments of our customers, understanding their microdisplay needs, and
designing products to meet those needs, both from a performance and cost point
of view. We recognize that our microdisplay products enable our customers to
deliver a positive user experience and to differentiate their products from
those of their competitors. We attempt to enhance the competitive position of
our customers by providing them with high-quality microdisplay products on a
timely and cost-effective basis that enable them to increase the functionality,
reduce the size, lower the cost, and enhance the user experience of their own
products. To do so, we work to improve our productivity, to reduce costs, and
to speed the delivery of our microdisplay products. We also devote
considerable effort to support our customers after the purchase of our
microdisplay products.

Develop Relationships with Leading OEMs

We seek to develop relationships with leading companies in high-growth
markets that have the greatest potential for using microdisplays, both
immediately and in the future. We are currently targeting various high-growth
markets, including large-screen, high-resolution televisions, multimedia and
home entertainment projectors, headsets for video games, and mobile wireless
communication devices. In addition, we are targeting specialized markets for
industrial, medical, and military applications. We believe our strategy of
targeting a wide array of applications in both the projector and near-to-eye
markets will enable us to enhance our technology, expand our customer base, and
achieve efficiencies of scale.

Provide Components, Modules, and Subsystems to Meet Customer Needs

We offer a range of product solutions designed to satisfy varying customer
needs in the most efficient manner. For example, certain projector customers
demand plug-and play light engine systems that can be simply installed as
part of their projection systems. Other applications for which we supply
subsystem solutions are medical, military, industrial, and consumer
applications.

Maintain Our Technological Leadership

We plan to utilize our extensive intellectual property portfolio and
technological expertise to provide competitive advantages, extend the
functionality of our products, and offer innovative products to our customers
across multiple market segments. We intend to continue to develop our
technology to increase the performance of our products while reducing their
size, weight, cost, and power consumption.

Capitalize on Manufacturing Know-How and Increase Manufacturing Efficiencies

We seek to emphasize our extensive manufacturing know-how. We utilize our
advanced manufacturing line at our Tempe facility with its experienced
manufacturing team to produce our microdisplay products. We seek to increase
our manufacturing efficiencies, yields, and quality to reduce the cost and to
speed the delivery of our products. We stress manufacturing processes, widely
available quality materials, and standard products and seek to leverage our
participation in both the projection and near-to-eye microdisplay markets.

Pursue Strategic Relationships and Acquisitions

We seek strategic relationships to enhance our ability to offer
value-added customer solutions, address new markets, gain market share, and
maintain technological leadership. We intend to enter into additional
strategic relationships with leading companies serving our target markets. We
also intend to acquire or make investments in companies that extend our
technology and enhance our business and competitive position.

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Products and Services

We currently sell both established and leading-edge display products, as
well as provide global manufacturing outsourcing solutions for display and
non-display related products and LCoSmicrodisplays.

Display Products

We design and manufacture display modules for use in the end products of
OEMs. We seek to provide our customers with high-performance,
information-rich, low-power consumption displays that have competitive
advantages in terms of size, cost, and product differentiation. To accomplish
this goal, our engineering and development activities focus on display products
intended to meet the current and future requirements of our target marketing.
We add value for our customers through our ability to integrate the design and
production process, which reduces the time between product conception and
market introduction. Our emphasis on engineering and manufacturing services
has positioned us to develop unique product solutions for our customers as they
seek displays with more information content at lower cost.

Our display product solutions provide OEMs with the following benefits:



| |  |  | access to specialized design and manufacturing technology and expertise;                                                                      
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | accelerated design process and reduced design and
manufacturing costs through the use of our specialized personnel,
equipment, and facilities;
|
| |  |  | reduced reliance on multiple suppliers for components and
integration of their production processes; and                                      
|
| |  |  | the ability to concentrate their own resources on the design,
production, and distribution of their core products.                            

We have developed a sophisticated design process to meet the specific
needs of our customers applications. Each design project normally involves a
cross-functional team of our engineers who are assigned to a customer program.
The team consults with the customers engineers throughout the design,
prototype development, and manufacturing process. We continue to supply
value-added engineering support after the design solution has been developed
and integrated into the manufacturing process in an ongoing effort to provide
customers with product performance enhancements and cost-reduction
opportunities.

By eliminating the duplication and overlap of investment and resources, we
and our OEM customers are able to work together more economically. We
concentrate on the development of our display technologies and their
applications to products, while our customers devote time and resources on
market development for these products.

A manufacturer of a complete system or product requiring a specific type
of visual display, such as a mobile handset, medical instrument, business
machine, or hand-held data collection device, represents a typical buyer for a
display module. For each display module, we work directly with our customer to
develop and produce the design and to manufacture the display module in
accordance with the customers specifications. We also provide value-added
services by assembling additional components onto the display module, such as
keypads, bezels, microphones, speakers, light guides, and optics.

Our historical target market consists of high-end monochrome passive
matrix LCD modules of 1/4 VGA (320 x 240 pixels) or less resolution,
primarily those having smaller than ten-inch diagonal screen sizes. We do not
address low-end LCD display markets, such as watches and calculators. In 2001,
we added color passive and active matrix LCD technologies for small display
product applications. In late 2002, we also added OLED display modules through
our strategic partnership with OSRAM Opto Semiconductor.

Through our acquisition of Advanced Video Technologies in the third
quarter of 2002, we also design and provide customized and ruggedized,
large-sized flat panel, touch screen, and rack mount systems for OEMs. Our
offerings include flat panel monitors in a variety of levels of integration
from a monitor with an integrated touch screen to a monitor with custom
electronic, mechanical, or cosmetic modifications, which will assist customers
transitioning from CRTs to flat panel displays. The acquisition enables us to
provide customers with complete custom LCD, CRT, and flat panel display
solutions.

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The difficulties in developing a customers custom display module include
frequently changing customer expectations, evolving customer requirements, and
changing customer end-product specifications. These factors result in lengthy
lead times for market introduction of customers products. To overcome the
traditional obstacles involved in display design and development, we have
developed the four-phase program development process described below. We
combine our program development process with our philosophy of being a
seamless extension of our customer. This results in a very flexible,
responsive, accurate, and fast development cycle that enables our customers to
introduce their products into the market rapidly. Our program development
process consists of the following phases:



| |  |  | Feasibility and concept phase. We work closely with our
customer to understand its requirements. Customer input varies from
rough sketches to detailed specifications. Experienced display
module design engineers work to develop conceptual solutions to
customer requirements that include both design and cost parameters. 
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Prototype phase. We conduct a design review with the
customer; complete a proposed design, including the electrical,
mechanical, and optical features of the display module; and deliver
a prototype to the customer.                                                                                                          
|
| |  |  | Pilot phase. We perform a thorough design review with our
customer, involving an analysis of performance, cost, and volume
production considerations. A successful pilot phase results in the
completion of any design changes, the ordering of the tooling
required for production, and the delivery of manufacturing samples.
|
| |  |  | High-volume production phase. We complete any required
changes in the manufacturing process, receive necessary tooling, and
commence high-volume production. All high-volume module production
takes place in either Manila or Beijing.                                                                                        

We also have developed our own standard products, which we have designed
and outsourced through Asian manufacturing companies. In addition, in January
2003, we entered into an agreement with Data International Co., Ltd. of Taiwan.
Under that arrangement, we have become the exclusive channel in the Americas
for standard custom LCD products manufactured by Data International. As a
result of the addition of the product portfolio of Data International, we
believe that we are now able to provide a full spectrum of display products and
manufacturing services.

Electronic Manufacturing Services

We provide integrated design, manufacturing, and supply chain solutions
that address all stages of our customers product life cycles, including
advanced engineering and design, new product introduction and prototyping,
global supply chain management, printed circuit board assembly, box build,
testing, logistics and distribution, and aftermarket services. We assist our
customers in the design and product introduction phases of development to
reduce product time-to-market and optimize designs for manufacturing. We
obtain competitive component pricing and greater sourcing flexibility for our
customers through our supply chain management expertise and our global
information systems. We utilize sophisticated assembly and manufacturing
techniques in order to provide the complex functionality and small product size
that is required by OEMs. We subject our manufactured products to a
comprehensive set of tests for quality, functionality, and reliability,
including, in most cases, product-specific tests that we often design for our
customers. In addition, we assist our customers in packaging and distribution
logistics for the final products delivered to their distribution channels or to
their end users. We also provide a wide range of aftermarket support, such as
repairs, refurbishment, systems upgrades, and spare part manufacturing. By
providing these design, engineering, manufacturing, and logistics services, we
enable our customers to focus on their core competencies and to enhance their
competitiveness by reducing the cost of their products, increasing product
performance and functionality, and shortening the time from product conception
to product introduction in the marketplace.

We offer a broad range of integrated services that provide customers with
total design, new product introduction, and manufacturing solutions to take a
product from initial design through production, testing, distribution, and
aftermarket support.

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Engineering and Design. We offer engineering, design, and related
services to assist our customers in designing products for optimal
manufacturing and testing. Our design for manufacturability services seeks to
achieve defect-free and cost-effective product designs, reduce product
development cycles, create high production yields, and establish superior
product quality. Our design for testability service focuses on achieving the
highest level of in-circuit and functional test coverage prior to product
shipment.

New Product Introduction and Prototyping. We offer technical services
that shorten the time it takes our customers to introduce their products into
the market and that helps them to optimize the commercial manufacturing of
their products. Our integrated approach draws on our engineering, design,
supply chain management, prototyping and production manufacturing, quality, and
test engineering experience to enable a fast, cost-effective ramp to volume
production. We are able to assist our customers with component selection,
materials strategies, supply chain development, manufacturing process
development, reliability modeling, quality plan development, and test plan
implementation.

Supply Chain Management. Our global supply chain services include
materials, logistics, and storage of materials for the manufacturing of goods
and deliveries of those goods to our customers. Our supply chain process
starts by choosing suppliers that provide high levels of quality, flexibility,
competitive prices, and value added delivery programs, all on a global basis to
service those needs. We communicate demand to these suppliers in the most
automated process available so that we can meet the needs of our customer for
swift reaction to change, maximize our inventory velocity and utilization, and
create a valued customer-supplier relationship. We have established with our
suppliers various delivery mechanisms from supplier delivery vehicles to
consolidated shipping containers. These methods vary based on cost and
proximity. These suppliers must also meet ongoing reviews for total cost
reduction, flexibility, and quality. Our global supply chain provides value to
our customers by increasing flexibility, reducing risk, improving
time-to-market, and lowering cost.

Assembly and Manufacturing. We provide turnkey and consigned
manufacturing and assembly services. These services include printed circuit
board and subsystems assembly, box build, system and subsystem integration,
downloading software, and building and configuring the final product.

Product Testing. We offer in-circuit testing of printed circuit boards
and functional testing of subsystems and systems, which contributes
significantly to our ability to deliver high-quality products on a consistent
basis. We work with our customers to develop product-specific test strategies.
Our test capabilities include design for test and manufacturing defect
analysis, in-circuit development and implementation, and functional tests. We
either custom design test equipment and software ourselves or use test
equipment and software provided by our customers. In addition, we provide
environmental stress tests to assure reliability.

Logistics and Distribution. We offer flexible services related to the
configuration and shipment of our customers products. We perform final
product packaging, out-of-box audit, and distribution services for completed
products as well as direct order fulfillment. We can deliver final products
directly into our customers distribution channels and to our customers
end-users. We believe that these services compliment our comprehensive
manufacturing solutions, enabling our customers to be more responsive to
changing market demands and to get their products to market more quickly with
less total cost.

Aftermarket Service. We provide a wide range of aftermarket services,
including repair, refurbishment, remanufacturing, system upgrades, and spare
part manufacturing. These services are supported by specific information
systems and testing technologies and can be tailored to meet specific customer
requirements.

LCoS Microdisplays

Introduction

We develop, manufacture, and market microdisplay products and system
solutions utilizing our liquid crystal on silicon, or LCoS, microdisplay
technology for a variety of markets. These markets include rear-projector
high-definition televisions; front-projector multimedia and home theater
projectors; and near-to-eye or personal display applications, including
head-mounted monocular or binocular headsets or viewers for industrial,
medical, military, commercial, and consumer applications. Our LCoS
microdisplays consist of a CMOS backplane, liquid crystal layer, and glass
packaged for connectivity using highly advanced packaging technologies.

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The display market continually demands greater information content at
reduced prices. We believe that the inherent capability of our LCoS technology
provides a cost-effective solution to increased information demands. Our LCoS
technology provides high-information content in a small size and at a low cost.
As a result, we believe our microdisplay products and system solutions address
market trends in those market segments that demand high-information,
high-resolution, power-efficient displays with increasing functionality and
smaller sizes at low costs.

There are various types of microdisplay technologies. Liquid crystal on
silicon microdisplays are a form of active matrix LCD in which liquid
crystalline material is suspended between a glass plate and a silicon backplane
rather than between two glass plates. The silicon backplane, which is
essentially an integrated circuit, provides drive signals for each pixel
element of the display as well as logic functions, such as serial to parallel
conversion and data storage. Because CMOS integrated circuits, which is a
highly developed technology, form the basis of these displays, liquid crystal
on silicon technology permits a very high-information content, high-performance
display in a small size and at a relatively low cost.

Product Line

Our microdisplay products include a line of LCoS display imagers and
associated application specific integrated circuits, or ASICs, optical modules,
and proprietary light engines and reference designs. Our imager products have
resolutions and sizes designed for specific market segment applications. The
following table sets forth certain information regarding our currently
available imagers and our BR1920 imager currently in development.

|             |  |                 |  |       |  |                                                                                              
|------------ |  | --------------- |  | ----- |  | ---------------------------------------------------------------------------------------------
|Model Number |  | Resolution      |  | Size  |  | Applications                                                                                 
|             |  |                 |  |       |  |                                                                                              
|             |  |                 |  |       |  |                                                                                              
|Z86D-3       |  | SVGA            |  | 0.47 |  | Near-to-eye                                                                                  
|             |  |                 |  |       |  |                                                                                              
|BR1024       |  | XGA             |  | 0.53 |  | Rear-projection television (4:3 aspect ratio)                                                
|             |  |                 |  |       |  |                                                                                              
|BR768        |  | HDTV1           |  | 0.70 |  | Rear-projection television (16:9 aspect ratio)                                               
|             |  |                 |  |       |  |                                                                                              
|BR1280       |  | SXGA            |  | 0.78 |  | Front projectors and photo printers                                                          
|             |  |                 |  |       |  |                                                                                              
|BR1920       |  | WUXGA and HDTV2 |  | 0.85 |  | Rear-projection full high-definition
television and other high-performance video
applications

In association with the display imagers listed in the table above, we sell
a line of ASICs that provide driver, controller, and converter functions in
order to deliver a complete imager solution. In addition, our product line
includes optical modules and light engines that incorporate illumination,
prisms, color separators and combiners, and lenses to provide complete display
solutions. We sell these complete display solutions as modules for near-to-eye
applications and proprietary light engines for projector applications. Our
microdisplay light engines also allow us to meet the different price points,
development times, and resolution requirements for a variety of customer
applications. The small microdisplays and precision optics included in our
light engines separate light into its three primary colors and then recombine
that light to produce brilliantly sharp images that cannot be accurately
reproduced by traditional display technology. Our products include development
kits and reference designs in order to accelerate time to market for our
customers.

Projector Applications

We serve several projection markets: the rear-projection, high-definition
television market with screen sizes of between 50 and 65 inches and the
high-end multimedia and home theater front-projection markets. Additionally,
we serve several smaller projection markets, including photo printer, digital
cinema, and specialty military applications.

For projection applications, we offer products with XGA, SXGA, and HDTV1
resolution and are developing products with HDTV2 resolution. We believe our
LCoS microdisplays have significant advantages over

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competing technologies in the consumer marketplace in terms of resolution,
image quality, size, and cost as well as in terms of manufacturability. In
rear-projection televisions, our light engines containing our LCoS
microdisplays replace the image-related components in a traditional
rear-projection CRT television at approximately one-third the weight and size,
while providing better image quality and much higher resolution.

Near-to-Eye Applications

We produce products to serve the near-to-eye market, including SVGA
imagers, display modules, and reference designs. Our display modules are
complete drop-in assemblies that allow customers to focus on end-product design
and packaging, because they can use our full color SVGA resolution microdisplay
as a drop-in assembly.

Our near-to-eye products utilize a viewfinder, typically mounted in a
headset, and provide image magnification. The image appears to the user with
the clarity, size, and resolution of a computer monitor. These products also
are compact, lightweight, and highly energy efficient. With high resolution
and small size, LCoS microdisplays offer unique advantages to these wearable
and portable products. Products based on LCoS microdisplays have long
lifetimes and can be made lightweight with low power requirements and display
sharp, bright images. Our LCoS microdisplays also withstand wide ambient
temperature ranges, a feature which is important for industrial and portable
applications. In addition, our associated ASICs enable fast rendering of
images, an important attribute for viewing full-motion video.

To date, our near-to-eye product sales have been concentrated in specific
industrial, medical, and military applications. Product shipments have
included LCoS microdisplays for monocular and binocular headmounted displays,
video telescopes, surgical microscopes, and riflescopes.

We are developing microdisplays for use in headsets for video games.
These microdisplay headset products are designed to provide users with an
enhanced video game experience. Like a joystick, our microdisplay headset
products will allow users new dimensions of interface with the games and a
greater immersion into the game.

We also are pursuing the development of microdisplay-based monocular or
binocular displays for use in various high-information content portable
electronic devices, such as mobile handsets, pagers, PDAs, and wireless
Internet appliances. Use of microdisplays in these personal display system
applications will enable users to view the information delivered by the device
at the same resolution as a desktop or notebook computer.

Another emerging market for LCoS microdisplays is mini-projectors for use
with PDAs, notebook computers, and other portable electronics. These
mini-projectors beam images onto walls, tabletops, or other surfaces for use by
individuals or small groups. Mini-projectors can allow new dimensions to be
added to users information manipulation and sharing capabilities. Any surface
can be turned into a virtual computer monitor using a mini-projector. This
small and seemingly simple accessory can turn computers, PDAs, and cell phones
into more versatile mobile offices.

Other Business Factors

Sales and Marketing

We approach sales and marketing on three levels: engineer to engineer,
salesperson to procurement, and factory to factory. Our approach is to treat
an existing program as a marketing platform for the next program. Our
engineering, marketing, and sales groups provide ongoing services to our
customers throughout the life of product programs. These services include
implementing continuous improvement tools related to both the products cost
and technical performance. This service function allows us to market future
sales within our customer base.

We market our services primarily in North America, Asia, and Europe
through a direct technical sales force resident in those areas. We also have
established an extensive network of representatives selling our display
solutions products throughout the world. A staff of in-house, Arizona-based
engineering personnel directs and aids all sales personnel.

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Our sales to customers in North America represented approximately 16.8% of
net sales in 2001 and 14.9% of net sales in 2002. Our sales to customers in
China represented approximately 40.6% of net sales in 2001 and 39.7% of net
sales in 2002. Our sales to customers in other foreign countries represented
approximately 42.6% of net sales in 2001 and 45.4% of net sales in 2002.

Customers

Historically, Motorola has been our largest customer. Sales to Motorola,
including its subcontractors, accounted for approximately 85.4% of our net
sales in 2001 and 76.9% of our net sales in 2002. No customer other than
Motorola accounted for more than 10.0% of our net sales in 2001 or 2002.
Substantially all of the net sales for Motorola programs in 2001 and 2002 were
for mobile handset applications. In 2002, we refocused our strategy on lower
volume programs with higher gross margins. As a result, in 2001 and 2002, we
received no design wins at Motorola for mobile handset applications. Instead,
our design wins with Motorola were in other low-volume applications, such as
telematics, which are cellular applications in automobiles. Based on the
recent absence of design wins and anticipated ranges of purchases indicated by
Motorola, we anticipate that purchases by Motorola from us will be
substantially less than prior levels. See Item 1 Business  Risk Factors  We
anticipate significantly lower business volume from our historically largest
customer. In fact, we expect that Motorola will comprise less than 10% of our
revenue in 2003.

In the past, our strategy in our LCD display business involved
concentrating our efforts on providing design and production services to
leading companies in mobile handsets and other wireless communication, data
collection, office automation, medical equipment, and other commercial and
consumer marketplaces. As a result, a significant portion of our net display
sales has resulted from services provided to a limited number of customers. We
have added an extensive standard product line with our acquisition of AVT and
our arrangement with Data International. In addition, we are developing our
own line of standard color display products. Therefore, as we have focused
more on niche applications with higher selling prices and lower volumes, the
breadth of our customer base has increased.

Customers for our electronic manufacturing services include large
multinational and smaller OEMs that have chosen outsourcing as a core
manufacturing strategy. We maintain relationships with OEMs in a diverse range
of industries, including automotive, computer/server, medical monitoring, and
Internet security. We believe we are able to offer these customers an
outsourcing solution that involves lower costs than typically would be provided
by their internal operations. We seek to differentiate ourselves from our
competitors by providing advanced methodologies and capabilities and
exceptional customer focus by integrating our services into our customers
operations. During 2002, we served more than 15 EMS customers.

We believe that there will be substantial synergy between our display
products group and our EMS group, providing us with a unique value proposition
for our target markets. The printed circuit board assembly and the display
represent a large portion of an OEMs bill of materials, thus allowing us to
offer one-stop shopping.

Backlog

As of December 31, 2002, we had a backlog of orders of approximately $32.0
million. The backlog of orders as of December 31, 2001 was approximately $18.7
million. Our backlog consists of product orders for which confirmed purchase
orders have been received and which are scheduled for shipment within 12
months. Orders are now given with only a six to eight week lead time. Most
orders are subject to rescheduling or cancellation by the customer with limited
penalties. Because of the possibility of customer changes in delivery
schedules or cancellations and potential delays in product shipments, our
backlog as of a particular date may not be indicative of net sales for any
succeeding period.

Manufacturing Services, Facilities, and Quality Control

Manufacturing Services

We have organized our manufacturing geographically to optimize the
combination of technology and labor factors. This organization enables us to
compete solely on the basis of cost, if necessary, with suppliers of similar
products and services throughout the world to the extent we determine to do so
based on profitability levels. Our advanced manufacturing techniques include
surface mount technologies, automated printed circuit board assembly,

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end circuit and functional testing, systems integration and box-build,
chip-on-board, chip-on-flex, chip-on-glass, flip-chip, tape automated bonding,
and sophisticated testing systems throughout these processes.

We seek to increase our value to our customers by providing responsive,
flexible, total manufacturing services. To date, our manufacturing services
have been concentrated on the manufacture of LCDs and assembly of display
modules that we have designed. We provide extended manufacturing services
beyond these core services, however, if the customer requires them. Extended
services may include adding additional components, such as keypads,
microphones, speakers, light guides, and optics, or the turnkey manufacture of
a complete assembly. In addition, we recently acquired ETMA Corporation, which
provides us additional manufacturing capabilities for products beyond display
modules. Specifically, ETMA provides engineering support, automated printed
circuit board assembly, end circuit and functional testing, systems integration
and box build, complete supply chain management, and turn-key packaging and
fulfillment services.

Manufacturing Facilities

We currently conduct manufacturing operations in Tempe, Arizona; Redmond,
Washington; Marlboro, Massachusetts; Manila, the Philippines; and Beijing,
China.

Our dedicated LCoSmicrodisplay production line is at our Arizona
facility. The facility consists of 16,000 square feet of Class 100, 1000, and
10,000 clean room areas where wafer scale LCoSprocessing, core assembly,
packaging, and automated testing is preformed. We perform all manufacturing,
packaging, and module assembly for LCoSproducts at our Arizona facility.
Facility personnel include a team of experts ranging from research scientists
to specialized engineers with backgrounds in electronics, mechanics, chemistry,
physics, and manufacturing. We maintain a wide variety of state-of-the-art
testing and quality control equipment at the facility.

The Arizona facility previously housed a fully automated LCD production
facility. We utilized this facility to manufacture high-volume LCD glass
panels and to conduct LCD research and development, to produce prototype and
pre-production runs of devices for customer approval, to conduct full
production runs of low-volume devices, and to develop advanced manufacturing
processes that could be applied in Manila and Beijing during full-scale
production. In 2001, we decided to shut down and move our front-end
manufacturing LCD line from Arizona to Asia. We now purchase all of our LCDs
from third parties although we sometimes purchase partially completed LCDs and
complete the back-end operations on those LCDs in Manila. During 2002, we
entered into a Cooperative Agreement with a China-based company. Under the
agreement, we sold the equipment of our front-end LCD line and established a
supply arrangement, providing for favorable LCD glass pricing and flexible yet
assured manufacturing capacity.

We provide aftermarket customization of CRT and LCD monitors in Marlboro,
Massachusetts. We operate state-of-the-art manufacturing facilities in
Redmond, Washington, Manila, and Beijing. In Manila and Beijing, we assemble
displays into modules and perform certain back-end LCD processing operations.
In Redmond, Washington, we provide engineering support, automated printed
circuit board assembly, in-circuit and functional testing, systems integration
and box build, complete supply chain management, and turn-key packaging and
fulfillment services.

Our Manila operations are housed in a custom-designed, built-to-suit
manufacturing facility in the Camelray Industrial Park near Manila in the
Philippines. The term of this lease for the factory in Manila is 125 months.
This new 65,000 square foot manufacturing and design facility incorporates
state-of-the-art manufacturing equipment and a class 10,000 cleanroom
environment. This new facility is focused on module manufacturing and is
staffed entirely with direct labor employed by us. In addition, the new
manufacturing facility has been outfitted with specific tooling and equipment
unique to our manufacturing needs. The new facility is located in a special
Philippines economic zone (PEZA), which allows us to take advantage of certain
tax benefits. Prior to opening our own facility in Manila, we operated certain
back-end LCD functions pursuant to a sub-assembly agreement with Technology
Electronic Assembly and Management Pacific Corporation, or TEAM. Those
services were performed in TEAMs buildings, but all functions were transferred
to our Camelray facility in 2002.

Our Beijing facility is a high-volume display module manufacturing
facility similar to our facility in Manila. We own the manufacturing facility
in Beijing, which we completed in 1999, and all of the equipment in

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that facility. In addition, we employ all of the direct and indirect
manufacturing employees at the facility, including technicians, supervisors,
and engineers.

Our Redmond, Washington facility is a lower-to-medium volume,
medium-to-high mix manufacturing facility focusing on electronic manufacturing
services. We lease this facility, and the remaining term of the lease is for
60 months. We also lease two additional facilities in Redmond, Washington.
One facility is used for final product assembly (box build) and logistics
operations and that facility has a remaining lease term of 37 months. The
third facility is used for rework, repair and storage with 46 months remaining
on its lease.

Quality Control

We recognize the need to maintain a strong reputation for quality as a
means of retaining existing customers and securing additional orders from them
as well as attracting new customers. We have an extensive quality control
program and maintain at each of our facilities quality systems and processes
that meet or exceed the demanding standards set by many leading OEMs in our
targeted industries. We base our quality control program upon statistical
process control, which advocates continual quantitative measurements of crucial
parameters and uses those measurements in a closed-loop feedback system to
control the manufacturing process. We perform product life testing to help
ensure long-term product reliability. We analyze results of product life tests
and take actions to refine the manufacturing process or enhance the product
design.

Increased global competition has led to increased customer expectations
with respect to price, delivery, and quality. Customers often evaluate price
in the quotation process and evaluate delivery and quality only after receiving
the product. Therefore, many customers preview a companys quality by viewing
the quality systems employed. We have received ISO 9001 and QS 9000
certifications of our Manila manufacturing facility and ISO 9001 certification
of our manufacturing facility and corporate headquarters in Tempe, Arizona.
Our Redmond facility is ISO 9002 certified. ISO and QS are quality standards
established by international organizations that attempt to ensure that the
processes used in development and production remain consistent. This is
accomplished through documentation maintenance, training, and management review
of the processes used. Although achieving an ISO or QS certification does not
assure that we will obtain future business, it is a factor that enables our
customers to recognize that our production processes meet these established,
global standards of performance.

Components and Raw Materials

Components and raw materials constitute a substantial portion of our
product costs. The principal components and raw materials we use in producing
our display products consist of LCD glass, silicon wafers (for LCoS
microdisplays), application specific integrated circuits, or ASICs, printed
circuit boards, molded plastic parts, lead frames, and packaging materials.
Our procurement strategy is to secure alternative sources of supplies for the
majority of these materials. Many of these materials, however, must be
obtained from foreign suppliers, which subjects us to the risks inherent in
obtaining materials from foreign sources, including supply interruptions and
currency fluctuations. Our suppliers generally are meeting our requirements,
and we believe our strategic supplier alliances have further strengthened our
relations with offshore suppliers. We experienced material shortages of ASICs
in 1999 and 2000 as a result of the increased worldwide demand for cellular
handsets and as a result of supplier issues encountered in the fourth quarter
of 2000. These shortages prevented us from meeting customer demand for certain
of our products. Similar shortages in the future could have a material adverse
effect on our business.

In providing electronic manufacturing services, we also purchase various
electronic components, including printed circuit boards, ASICs, semiconductors,
interconnect products, memory modules, power supply modules, cable and wire
harnesses, resistors, and capacitors as well as components for use in assembly
and manufacturing, including injection-molded plastic, pressure-forward
plastics, vacuum-formed plastics, sheet metal fabrication, aluminum extrusions,
die castings, and various other hardware and fastener components. Some of
these components and raw materials are standard and others are highly
customized and they vary widely in terms of market availability, volatility,
and price.

We attempt to procure components and other raw materials only when a
purchase order or forecast is received from a customer. We experience
component shortages and longer lead times for various components and raw
materials from time to time. We generally have been able to reduce the impact
of shortages by working with

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customers to reschedule deliveries and by working with suppliers to
provide the needed components using just-in-time vendor managed or consigned
inventory programs.

Research, Development, and Engineering

We conduct an active and ongoing research, development, and engineering
program that focuses on advancing technology, developing improved design and
manufacturing processes, and improving the overall quality of the products and
services that we provide. Our goal is to provide our customers with new
solutions that address their needs. Research and development personnel
concentrate on improving the performance of current products and expanding the
technology to serve new markets. We also conduct research and development in
manufacturing processes, including those associated with efficient, high-volume
production and electronic packaging.

We have also undertaken a significant research and development program and
made substantial investments with respect to the development of our LCoS
microdisplays. The majority of our available research and development
personnel hours was dedicated to LCoSmicrodisplays in 2001 and 2002, and we
expect that to continue in 2003.

Intellectual Property

We rely on a variety of intellectual property methods, including patents,
trade secrets, trademarks, confidentiality agreements, licensing agreements,
and other forms of contractual provisions, to protect and advance our
intellectual property. Although our existing LCD display business has not
historically depended on intellectual property protection, we are strongly
focused on our LCoSintellectual property rights:



| |  |  | We have filed numerous patents relating to our LCoS
microdisplay technology. These patents cover the areas of product
design and manufacturing process technology. We have a strong
emphasis in this area and expect to continue to file additional
disclosures. We have over 300 patents issued, filed, or disclosed.
There can be no assurance that any patent applications will be
issued to us.                                                                                                                                                                                                                                                              
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | In July 1999, we purchased the assets, including all
production and test equipment, specialized laboratory equipment, and
supporting design documentation and software, of the former Light
Valve business unit of National Semiconductor. We also hired
several key scientists of that business unit and acquired an
exclusive, paid-up, royalty free license on all of the patents and
intellectual property related to that business unit. This license
covers all intellectual property relating to the processing,
packaging, and testing of light valves and the integrated circuits
necessary to manufacture and sell both light valves and light
engines.
|
| |  |  | In August 1999, we licensed the microdisplay technology of
S-Vision Corporation, a former microdisplay competitor that had
recently ceased operations. Under this agreement, we acquired an
irrevocable, royalty free, fully paid-up, worldwide license to the
intellectual property associated with S-Visions digital backplane
and optical systems, which provides us rights to manufacture certain
microdisplay products and patented optical engines. In addition,
S-Vision assigned to us a patent relating to the design and
manufacture of microdisplay products.                                                                                        
|
| |  |  | In January 2002, we purchased all of the intellectual
property of Zight Corporation, a private company that focused on
microdisplays for personal display system applications. In
addition, we purchased certain key assets of Zights at a creditors
auction and hired seven key technical persons formerly employed by
Zight.                                                                                                                                                                                                                                                                                                                                 
|
| |  |  | In April 2002, we purchased all of the intellectual property
of Inviso Corporation, a private company that also focused on
microdisplays for personal display system applications.                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  |  | In January 2003, we were awarded a registered trademark on
LCoS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

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Competition

We believe that Philips, Samsung, Seiko-Epson, Hosiden, Optrex, Seiko
Instruments, Wintek, and Sharp constitute the principal competitors for our
display products and solutions. Most of these competitors are large companies
that have greater financial, technical, marketing, manufacturing, vertical
integration, and personnel resources than we possess. Our sales,
profitability, and success depend substantially upon our ability to compete
with other providers of display modules. We cannot provide assurance that we
will continue to be able to compete successfully with these organizations. We
currently compete principally on the basis of the technical innovation,
engineering service, and performance of our display modules, including their
ease of use and reliability, as well as on their cost, timely design, and
manufacturing and delivery schedules. Our competitive position could be
adversely affected if one or more of our customers determines to design and
manufacture their display modules internally or secures them from other
parties.

We believe Benchmark Electronics, Plexus, Pemstar, SMTC Manufacturers
Services, and other smaller, proximity-based domestic EMS providers constitute
our principal competitors in supplying electronic manufacturing services. We
compete primarily on the basis of engineering, testing, and production
capabilities; technological know-how; the responsiveness, quality, flexibility,
and price of our services; and geographical location. Many of our competitors
have substantially greater manufacturing, financial, and research and
development resources than we possess and offer broader geographic operations
and a greater range of services than we do. We also face competition from the
manufacturing operations of current and potential customers, which continually
evaluate the benefits of internal manufacturing versus outsourcing.

We believe that Texas Instruments, JVC, Hitachi, Aurora Systems,
SpatiaLight, Epson, and Sony constitute the principal competitors for our
microdisplay products. Texas Instruments has developed a product, referred to
as a DMD microdisplay, that competes with our LCoS technology. JVC, Hitachi,
Aurora, and SpatiaLight are developing or producing liquid crystal on silicon
displays that are similar to our LCoS display based on their own technology.
Epson and Sony manufacture transmissive polysilicon, which is a type of
microdisplay that can be used in some of the same applications as LCoS
microdisplays. Numerous other established and start-up companies are also
pursuing similar and related technologies that may compete with our LCoS
technology.

Our competitive position in our microdisplay business results from broad
liquid crystal on silicon capabilities, mature technologies, high-volume
manufacturing, financial strength, and current customer relationships. Based
on these factors, we believe we are the only full-service independent choice
for OEMs that wish to use liquid crystal on silicon in the projector and
near-to-eye markets.

Strategic Acquisitions, Investments, and Alliances

In 1997, we entered into a strategic alliance with National Semiconductor
Corporation for the development of LCoSmicrodisplay products. Under that
alliance, National Semiconductor focused on the silicon technologies needed for
microdisplays, and we focused on the liquid crystal technologies. In 1999,
National Semiconductor decided to close its microdisplay business unit. In
connection with that closing, in July 1999, we purchased certain assets and
licensed silicon technologies from National Semiconductor relating to LCoS
microdisplays. We paid approximately $3.0 million in cash and issued warrants
to purchase 140,000 shares of our common stock in the transaction, which valued
the transaction at approximately $3.6 million. No additional payments are
required under the licenses. We also hired several key technical employees of
National Semiconductor to assist in the implementation of the acquired
technologies.

In April 1998, we entered into a strategic relationship with Inviso, Inc.,
a privately held company with numerous patents and proprietary technology
related to microdisplay development. We acquired a minority equity interest in
Inviso for approximately $3.3 million. In March 2000, we acquired an
additional interest in Inviso for $500,000, raising our total minority equity
interest to $3.8 million. As part of this strategic relationship, we provided
proprietary manufacturing capabilities and liquid crystal expertise, and Inviso
provided patented and proprietary technologies and components for the joint
development of microdisplay products. In the second quarter of 2001, we wrote
off our investment of $3.8 million in Inviso because we determined that our
investment was impaired, as that term is defined under generally accepted
accounting principles. Subsequent to our write-off, Inviso

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was unable to raise funds to operate its business and ceased operations.
A total of $780,000 was spent in 2002 obtaining all of the intellectual property of
Inviso.

In August 2000, our wholly owned subsidiary, Three-Five Systems (Beijing)
Co., Ltd., entered into a strategic agreement with Heibei Jiya Electronics,
Co., Ltd. (Jiya), a Chinese-based manufacturer of LCD glass. Under the terms
of the agreement, Jiya agreed to provide LCD glass to us and reserve a
significant amount of LCD glass manufacturing capacity for us. In exchange, we
agreed to assist Jiya in further developing its LCD glass manufacturing
processes. At the end of the agreement term in February 2002, we had the
option to extend the agreement or to acquire a majority interest in Jiya. We
elected not to extend the agreement or acquire a majority interest.

In 2001, we invested $1.25 million in Silicon Bandwidth, Inc., a privately
held company providing unique semiconductor and optoelectronic interconnect
solutions based upon multiple, patented, proprietary technologies. We are
working closely with Silicon Bandwidth to design unique, cost-effective,
reconfigurable packaging platforms for LCoSmicrodisplays.

During the second quarter of 2001, we formed a new company, Three-D OLED
L.L.C., with Dupont Displays, a business unit of Dupont Corporation. We owned
51% of this new venture, and Dupont Displays owned 49%. The companies pledged
$3.0 million to the venture. Our share of that obligation was slightly over
$1.5 million. This venture was formed to design, assemble, and market organic
light emitting diode, or OLED, display modules to OEMs worldwide with the focus
on glass substrate, passive matrix OLED displays. In the second quarter of
2002, we agreed with Dupont Displays to liquidate our joint venture with
Three-D OLED L.L.C. and enter into a non-equity based Strategic Manufacturing
and Supply Agreement. Under that agreement, the parties will continue to work
together in a fashion similar to the venture, but the relationship will be
nonexclusive. We have not worked with Dupont since the liquidation.

In January 2002, we purchased the intellectual property of Zight
Corporation, a private company focused on microdisplays for personal display
system applications. In addition, we purchased certain key assets of Zight at
a creditors auction, and we hired seven key technical persons formerly
employed by Zight. The total purchase price was approximately $2.6 million, of
which approximately $2.0 million was related to intangibles.

In January 2002, we entered into an agreement with China Display Digital
Image Technology (Shanghai) Co., Ltd. Under the arrangement, China Display
will develop high-performance light engines using our microdisplays.

In July 2002, we invested $5.0 million in ColorLink, Inc. ColorLink has a
leading position worldwide in the development and manufacture of color
management technologies for LCoSmicrodisplays. ColorLinks products consist
of color management components and system architectures that are critical for
digital projection systems that use high-resolution microdisplays. Those
projection systems include color monitors, high-definition televisions, and
multi-media projectors. This investment furthers our efforts to accelerate as
much as possible the establishment of the necessary infrastructure for LCoS
microdisplays. An additional $81,000 was recorded as investment in ColorLink
during the third quarter of 2002 for legal and due diligence expenses.

In July 2002, we entered into an agreement with Advanced Digital Optics,
Inc., or ADO, a company that specializes in the design and development of light
engines used in projection displays. Under the agreement, we are working with
ADO to develop light engines for use in rear-projection televisions.

In August 2002, we entered into an agreement with Accupix, Inc. The
arrangement provides for Accupix to provide optical module designs as well as
local optics and electronics support for our customers developing near-to-eye
microdisplay applications.

In September 2002, we entered into an agreement with Visual Interaction
GmbH. Under the arrangement, Visual Interaction will provide local optics and
electronic support for the European market and offer module reference designs
for our customers developing near-to-eye microdisplay applications.

In September 2002, we purchased the assets and ongoing business of
Advanced Video Technologies (AVT), a privately held company that specializes in
the design and integration of complex, high-resolution display

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systems. AVT designs and provides customized and ruggedized flat panel,
touchscreen, and rackmount systems for OEMs, including General Electric,
Westinghouse, Gillette, and the U.S. military. AVT sources its display
components from a variety of companies including Sony, Sharp, NEC, LG, and
Samsung. The purchase price of the acquisition was $12.0 million, which we
paid entirely in cash. The purchase agreement also calls for a residual
purchase payment of $2.0 million should the AVT division achieve certain
revenue and profit objectives for 2002 and 2003.

In November 2002, we entered into a marketing and technology agreement
with Duraswitch. Under the arrangement, we will make our display system
services, products, and manufacturing services, including training and sales
support, available to Duraswitchs OEM customers in the appliance, computer,
and medical markets, and Duraswitch will provide us with training, engineering,
and marketing support in bringing its patented switch technologies to our
customers.

In December 2002, we purchased the stock of ETMA Corporation, a privately
held electronic services manufacturer for OEM customers in the automotive,
computer/server, medical monitoring, and Internet security industries. ETMA
offers the manufacturing capabilities of six surface mount manufacturing lines,
including one dedicated to new product introduction and prototyping activity.
ETMA provides engineering support, automated printed circuit board assembly,
in-circuit and functional testing, systems integration and box build, complete
supply chain management, and turnkey packaging and fulfillment services. The
purchase price of the acquisition was $38.1 million, which we paid entirely in
cash.

In December 2002, we entered into an arrangement with OSRAM Opto
Semiconductors GmbH to collaborate in the design and marketing of OLED display
products. Under the strategic alliance we will provide design and engineering
services to support the integration of OSRAMs technologies and product
configuration into customer products and have the ability to market OSRAMs
standard OLED display products through our market channels.

In January 2003, we signed licensing and manufacturing agreements with
Data International Co., Ltd. of Taiwan. Under those agreements, we will become
the exclusive sales channel in North and South America for standard and custom
LCD products manufactured by Data International. We will also have the right
to sell those products through its worldwide channels. The agreements provide
us with access to a full suite of standard display products that will round out
our existing standard product portfolio. In conjunction with the agreement, we
established a sales office in Orlando and hired sales and applications
engineering personnel who have supported Data Internationals products
throughout North and South America for the past ten years. The cost of the
license is anticipated to be $4.0, of which $1.0 million was paid upon signing
with the remaining $3.0 million due over the next two years. The unpaid $3.0
million is subject to reduction if certain revenue and margin targets are not
met.

Government Regulation

Our operations are subject to certain federal, state, and local regulatory
requirements relating to environmental, waste management, health, and safety
matters. We believe we operate in substantial compliance with all applicable
requirements. There can be no assurance, however, that material costs and
liabilities will not arise from complying with these or from complying with
new, modified, or more stringent requirements. In addition, our past, current,
or future operations may give rise to claims of exposure by employees or the
public or to other claims or liabilities relating to environmental, waste
management, or health and safety concerns.

Our operations create a small amount of hazardous waste, including various
epoxies, gases, inks, solvents, and other wastes. The amount of hazardous
waste we produce may increase in the future depending on changes in our
operations. The general issue of the disposal of hazardous waste has received
increasing focus from federal, state, local, and international governments and
agencies and has been subject to increasing regulation.

In 1991, we received a notice of potential liability at the
Barkhamsted-New Hartford Landfill Site (the Landfill) in Barkhamsted,
Connecticut from the United States Environmental Protection Agency (EPA).
Fifty-seven other entities received similar letters. In January 1992, we
received a 104(e) questionnaire from the EPA which was completed and submitted
during 1992. We received verbal notification that we had no further liability
in the matter. According to the EPA, groundwater contamination at the site,
which includes volatile and semi-volatile organic compounds and low
concentrations of metals, constitutes a low-level threat. As a result of
previous actions

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at the site, groundwater is the only medium requiring additional cleanup.
All source material and principal threats have been addressed through the
landfill capping and related activity completed in 1999. On February 28, 2002,
we received notification from the EPA that the EPA believes we were an involved
party and indicated that the EPA was seeking to negotiate an agreement with the
involved parties to fund the EPAs chosen remedy of monitored natural
attenuation of the groundwater. We have reached a settlement on that matter
for $65,000 and have no further liability with respect to this issue.

Employees

As of December 31, 2002, we employed a total of 1,354 persons, including
32 in finance, accounting, and administration; 30 in sales and
marketing; 1,221
in manufacturing and assembly; and 71 in research, development and engineering.
Of our employees, 158 were employees at our principal U.S. facility in Arizona
and U.S. sales offices; 15 were employees at our manufacturing facility in
Marlboro, Massachusetts; 12 were employees at our R&D facility in Boulder,
Colorado; 187 were employees at our manufacturing facility in Redmond,
Washington; 498 were employees at our manufacturing facility in Manila; 479
were employees at our manufacturing facility in Beijing; and five were
employees at our Three-Five Systems Limited subsidiary in Swindon, England. We
consider our relationship with our employees to be good, and none of our
employees currently are represented by a union in collective bargaining with
us.

Executive Officers

The following table sets forth certain information regarding our executive
officers:

|                    |  |     |    |          |  |                                                                                      
|------------------- |  | --- | -- | -------- |  | -------------------------------------------------------------------------------------
|Name                |  | Age |    | Position
|                    |  |     |    |         
|Jack L. Saltich     |  |     | 59 |          |  | President, Chief Executive Officer, and Director                                     
|                    |  |     |    |          |  |                                                                                      
|Jeffrey D. Buchanan |  |     | 47 |          |  | Executive Vice President, Chief Financial Officer, Secretary,
Treasurer, and Director
|                    |  |     |    |          |  |                                                                                      
|Carl E. Derrington  |  |     | 52 |          |  | Vice President, Chief Manufacturing Officer                                          
|                    |  |     |    |          |  |                                                                                      
|Robert L. Melcher   |  |     | 63 |          |  | Chief Technology Officer                                                             
|                    |  |     |    |          |  |                                                                                      
|Van H. Potter       |  |     | 44 |          |  | Vice President-Display Products                                                      

Jack L. Saltichhas served as a director and the President and Chief
Executive Officer of our company since July 1999. Mr. Saltich served as Vice
President of Advanced Micro Devices from May 1993 until July 1999; as Executive
Vice President of Applied Micro Circuits Corp. from January 1991 until March
1993; and as Vice President of VLSI from July 1988 until January 1991. Mr.
Saltich held a variety of executive positions for Motorola from July 1971 until
June 1988. These positions included serving as an Engineering Manager from May
1974 until January 1980, an Operation Manager from January 1980 until May 1982,
a Vice President and Director of the Bipolar Technology Center from May 1982
until June 1986, and a Vice President and Director of the Advanced Product
Research and Development Laboratory from June 1986 until June 1988.

Jeffrey D. Buchananhas served as a director and Executive Vice President
of our company since June 1998; as Chief Financial Officer and Treasurer since
June 1996; and as Secretary since May 1996. Mr. Buchanan served as our Vice
President  Finance, Administration, and Legal from June 1996 until July 1998
and as our Vice President  Legal and Administration from May 1996 to June
1996. Mr. Buchanan served from June 1986 until May 1996 as a business lawyer
with OConnor, Cavanagh, Anderson, Killingsworth & Beshears. Mr. Buchanan was
associated with the international law firm of Davis Wright Tremaine from 1984
to 1986, and he was a senior staff person at Deloitte & Touche from 1982 to
1984.

Carl E. Derringtonhas served as our Chief Manufacturing Officer since May
1999. Dr. Derrington joined our company in 1986 as a Director of Research and
Development. Since that time, Dr. Derrington has served as a Plant Manager
from January 1986 until September 1987, a Director of Engineering from
September 1987 until

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August 1989, a Director of Manufacturing from August 1989 until April
1996, and a Director of Manufacturing Engineering from April 1996 until April
1999.

Robert L. Melcherhas served as our Chief Technology Officer since October
1999. Prior to joining our company, Dr. Melcher was employed at IBM in a
variety of management positions from 1970 until October 1999. He served as the
Program Leader for Projection Displays from 1993 to 1999 and immediately prior
to that he was Director of the Physical Sciences Department from 1990 to 1993.

Van H. Potterhas served as Vice President-Display Products since February
2003. Mr. Potter was Market Development Manager and Project Manager for Rogers
Corporation, a manufacturer of specialty polymer composite materials, from
February 2002 until February 2003. From April 1994 until February 2002, Mr.
Potter held a variety of management, marketing, and new business development
positions with Durel Corp., a joint venture between Rogers Corporation and 3M
Corporation.

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RISK FACTORS

You should carefully consider the following factors, in addition to those
discussed elsewhere in this report, in evaluating our company and our business.

We anticipate substantially lower business volume from our historically largest
customer.

Motorola, including its subcontractors, has been our largest customer
during each of the last seven years. Sales of Motorola products accounted for
approximately 76.9% of our net sales in 2002, 85.4% in 2001, 86.9% in 2000,
86.1% in 1999, and 63.6% in 1998. Substantially all of our sales of Motorola
products were for mobile handset applications. A significant decline in sales
to Motorola is expected to occur in 2003 primarily as a result of our receiving
no new design wins in 2001 or 2002 for Motorolas handset business. In the
fourth quarter of 2002, our Motorola revenue accounted for only 55% of our
business. We expect our Motorola business to account for less than 20% of our
business in the first quarter of 2003, and less than 10% of our revenue in the
second quarter of 2003.

Our revenue from LCD products may decline significantly in 2003.

The years 2001 and 2002 were characterized by a worldwide lack of growth
in the handset market and excess LCD capacity. As a result, some OEMs expected
custom LCD modules used in low-end handsets to be sold below industry costs.
We made the strategic decision, however, not to sell our custom LCD products
below standard industry costs. Instead, we are focusing on lower-volume,
higher-priced LCD products that utilize our advanced technologies and
engineering services. As a result of our strategic decision, however, our
volume of unit shipments and, consequently, our revenue from LCD products, have
declined and may continue to decline significantly.

We recently entered the electronic manufacturing services business.

We recently entered the electronic manufacturing services business through
our acquisition of ETMA Corporation. Among other things, we will be required
to integrate the operations of that company with our high-volume manufacturing
operations in Manila and Beijing.

We are in the process of substantially expanding our electronic
manufacturing services, which will result in various risks, including the
following:



| |  |  | the integration of worldwide operations;                                                                
| | - |  | --------------------------------------------------------------------------------------------------------
|
| |  |  | the ability to procure and install necessary additional equipment;                                      
|
| |  |  | the ability to hire, train, and manage additional manufacturing personnel;                              
|
| |  |  | production delays, unfavorable manufacturing yields, and lengthening delivery schedules;                
|
| |  |  | the ability to service widespread customers in varied industries;                                       
|
| |  |  | the need to satisfy increasingly rapid product turnaround
time and rapid increases in production levels;
|
| |  |  | the volume of customer orders relative to our capacity;                                                 
|
| |  |  | the typically short life cycle of our customers products;                                              
|
| |  |  | changes in our sales mix to our customers;                                                              
|
| |  |  | the timing of our expenditures in anticipation of future orders;                                        
|
| |  |  | our effectiveness in managing manufacturing processes;                                                  
|
| |  |  | changes in cost and availability of labor and components;                                               
|
| |  |  | changes in economic conditions; and                                                                     
|
| |  |  | local events that affect our production volume.                                                         

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The electronic manufacturing services industry is impacted by the state of
the electronics industry, general U.S. and global economic conditions, and
worldwide events. A continued slowdown in the U.S. or global economies or the
particular industries served by us may result in customers reducing orders.
Our revenue may be adversely impacted by the slowdown in the worldwide
electronics markets, which have been subject to reduced end-market demand and
reduced capital spending.

Our emerging microdisplay business may not be successful.

A key element of our current business plan involves the further
commercialization of our microdisplay technology. The microdisplay division
has never been profitable, and the success of this effort depends on numerous
factors. We may be unable to expand our microdisplay business as we currently
anticipate. We may make substantial investments in product development,
manufacturing, and marketing efforts that may not result in microdisplay sales.
Finally, we may have insufficient capital if there are delays in development,
manufacturing, and marketing efforts

Manufacturing an LCoSmicrodisplay involves a significantly different
procedure than manufacturing a typical liquid crystal display. Although we
added additional equipment to our Arizona manufacturing facility in the last
two years for manufacturing LCoSmicrodisplays, the manufacture of
microdisplays will require us to overcome numerous challenges, including the
following:



| |  |  | the availability of a sufficient quantity of quality materials;       
| | - |  | ----------------------------------------------------------------------
|
| |  |  | the implementation of new manufacturing techniques;                   
|
| |  |  | the incorporation of new handling procedures;                         
|
| |  |  | the maintenance of clean manufacturing environments; and              
|
| |  |  | the ability to master tighter tolerances in the manufacturing process.

We experienced significant technical and production issues in commencing
volume production of LCoSmicrodisplays in 2001 and 2002, and those issues
could continue through 2003. These issues could result in the delay of the
full implementation of high-volume LCoSmicrodisplay production. In addition,
we experienced lower than expected manufacturing yields in LCoSmicrodisplays.
Continued lower than expected manufacturing yields could significantly and
adversely affect us because of the relatively high cost of the silicon
backplanes used in LCoSmicrodisplays.

Various target markets for our microdisplays, including projectors,
monitors, digital and high-definition televisions, and portable microdisplays,
are uncertain, may be slow to develop, or could utilize competing technologies,
especially polysilicon and DMDs. Many manufacturers have well-established
positions in these markets. As a result, we must provide customers with lower
cost, comparable performance microdisplays for their products. Digital and
high-definition television has only recently become available to consumers, and
widespread market acceptance is uncertain. Penetrating this market will
require us to offer an improved value proposition to existing technology. In
addition, the commercial success of the portable microdisplay market is
uncertain. Gaining acceptance in this market may prove difficult because of
the radically different approach of microdisplays to the presentation of
information. The failure of any of these target markets to develop as we
expect, or our failure to penetrate these markets, will impede our anticipated
sales growth. Even if our technology successfully meets our price and
performance goals, our customers may not achieve commercial success in selling
their products that incorporate our microdisplay technology.

We face intense competition.

In our display business, we serve intensely competitive industries that
are characterized by price erosion, rapid technological change, and competition
from major domestic and international companies. Many of our competitors have
greater market recognition, larger customer bases, and substantially greater
financial, technical, marketing, distribution, and other resources than we
possess. In 2001, some OEM customers began expecting to purchase display
modules at prices below industry costs, and many of our competitors agreed to
those requests. Continued competition of this kind could result in additional
pricing pressures, lower sales, reduced margins, and

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lower market share. Our competitive position could suffer if one or more
of our display customers decide to design and manufacture their own display
modules, to use standard devices, that we do not offer, to contract with our
competitors, or to use alternative technologies that we may not possess. In
addition, our customers sometimes develop a second source, even for displays we
design for them. These second source suppliers may win an increasing share of
a program, particularly as it grows and matures, by competing primarily on
price rather than on design capability.

In our electronic manufacturing services business, we compete primarily on
the basis of our engineering, design, testing, and production capabilities; our
technological know-how; the responsiveness, quality, flexibility, and price of
our services; and our geographic locations. Many of our competitors in this
business have substantially greater manufacturing, financial, research, and
development resources than we possess and offer broader geographic operations
and a greater range of service offerings than we do. We also face competition
from the manufacturing operations of current and potential customers, which
continually evaluate the benefits of internal manufacturing versus outsourcing.

Our ability to compete successfully depends on a number of factors, both
within and outside our control. These factors include the following:



| |  |  | our success in designing, manufacturing, and/or procuring new
products and product solutions, including those implementing new
technologies;                                                                                                
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | our ability to address the needs of our customers;                                                                                                                                                                                          
|
| |  |  | the pricing, quality, performance, reliability, features,
ease of use, and diversity of our product solutions and services;                                                                                                                 
|
| |  |  | foreign currency devaluations, especially in Asian
currencies, such as the Japanese yen, the Korean won and the
Taiwanese dollar, which may cause foreign competitors products to
be priced significantly lower than our product solutions;
|
| |  |  | the quality of our customer services;                                                                                                                                                                                                       
|
| |  |  | our efficiency of production;                                                                                                                                                                                                               
|
| |  |  | the rate at which customers incorporate our product solutions into their own products; and                                                                                                                                                  
|
| |  |  | product or technology introductions by our competitors.                                                                                                                                                                                     

Any acquisitions that we undertake could be difficult to integrate, disrupt our
business, dilute stockholder value, and harm our operating results.

We plan to continue to review opportunities to buy other businesses or
technologies that would complement our current products, expand the breadth of
our markets, enhance our technical capabilities, or otherwise offer other
growth opportunities. In the past 12 months, we have acquired technologies,
assets and goodwill from five companies, and we will likely buy businesses,
products, or technologies in the future. If we make any future acquisitions,
we could issue stock that would dilute existing stockholders percentage
ownership, incur substantial debt, or assume contingent liabilities. Our
recent acquisitions, as well as potential future potential acquisitions,
involve numerous risks, including the following:



| |  |  | problems integrating the purchased operations, technologies, products, or services with our own;
| | - |  | ------------------------------------------------------------------------------------------------
|
| |  |  | unanticipated costs associated with the acquisition;                                            
|
| |  |  | diversion of managements attention from our core businesses;                                   
|
| |  |  | adverse effects on existing business relationships with suppliers and customers;                
|
| |  |  | risks associated with entering markets in which we have no or limited prior experience; and     
|
| |  |  | potential loss of key employees and customers of purchased organizations.                       

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Our acquisition strategy entails reviewing and potentially reorganizing
acquired business operations, corporate infrastructure and systems, and
financial controls. Unforeseen expenses, difficulties, and delays frequently
encountered in connection with rapid expansion through acquisitions could
inhibit our growth and negatively impact our profitability. We may be unable
to identify suitable acquisition candidates or to complete the acquisitions of
candidates that we identify. Increased competition for acquisition candidates
may increase purchase prices for acquisitions to levels beyond our financial
capability or to levels that would not result in the returns required by our
acquisition criteria. In addition, we may encounter difficulties in
integrating the operations of acquired businesses with our own operations or
managing acquired businesses profitably without substantial costs, delays, or
other operational or financial problems.

We may issue common or preferred stock and incur substantial indebtedness
in making future acquisitions. The size, timing, and integration of any future
acquisitions may cause substantial fluctuations in operating results from
quarter to quarter. Consequently, operating results for any quarter may not be
indicative of the results that may be achieved for any subsequent quarter or
for a full fiscal year. These fluctuations could adversely affect the market
price of our common stock.

Our ability to grow through acquisitions will depend upon various factors, including the following:



| |  |  | the availability of suitable acquisition candidates at attractive purchase prices,                    
| | - |  | ------------------------------------------------------------------------------------------------------
|
| |  |  | the ability to compete effectively for available acquisition opportunities, and                       
|
| |  |  | the availability of funds or common stock with a sufficient
market price to complete the acquisitions.

As a part of our acquisition strategy, we frequently engage in discussions
with various companies regarding their potential acquisition by us. In
connection with these discussions, we and each potential acquisition candidate
exchange confidential operational and financial information, conduct due
diligence inquiries, and consider the structure, terms, and conditions of the
potential acquisition. In certain cases, the prospective acquisition candidate
agrees not to discuss a potential acquisition with any other party for a
specific period of time, grants us an option to purchase the prospective
business for a designated price during a specific time, and agrees to take
other actions designed to enhance the possibility of the acquisition, such as
preparing audited financial information. Potential acquisition discussions
frequently take place over a long period of time and involve difficult business
integration and other issues, including in some cases, management succession
and related matters. As a result of these and other factors, a number of
potential acquisitions that from time to time appear likely to occur do not
result in binding legal agreements and are not consummated.

We cannot assure you that we would be successful in overcoming problems
encountered in connection with such acquisitions, and our inability to do so
could adversely affect our business.

We are subject to lengthy development periods and product acceptance cycles.

We sell our products and services to OEMs, which then incorporate them
into the products they sell. OEMs make the determination during their product
development programs whether to incorporate our products and services or pursue
other alternatives. This requires us to make significant investments of time
and capital well before our customers introduce their products incorporating
these products and services and before we can be sure that we will generate any
significant sales to our customers or even recover our investment.

During a customers entire product development process, we face the risk
that our products will fail to meet our customers technical, performance, or
cost requirements or will be replaced by a competing product or alternative
technological solution. Even if we complete our design or new production
introduction process in a manner satisfactory to our customer, the customer may
delay or terminate its product development efforts. The occurrence of any of
these events would adversely affect our operating results. The lengthy
development period also means that it is difficult to immediately replace an
unexpected loss of existing business.

We do not have long-term purchase commitments from our customers.

Our customers generally do not provide us with firm, long-term volume
purchase commitments. In addition, the worldwide adverse economic slowdown
commencing in 2001 has led to radically shortened lead times

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on purchase orders. Although we sometimes enter into manufacturing
contracts with our customers, these contracts clarify order lead times,
inventory risk allocation, and similar matters rather than provide firm,
long-term volume purchase commitments. As a result, customers can generally
cancel purchase commitments or reduce or delay orders at any time. The
cancellation, delay, or reduction of customer commitments could result in
reduced revenue and in our holding excess and obsolete inventory or having
unabsorbed manufacturing capacity. The large percentage of our sales to
customers in the electronics industry, which is subject to severe competitive
pressures, rapid technological change, and product obsolescence, increases our
inventory and overhead risks.

In addition, we make significant decisions, including determining the
levels of business that we will seek and accept, production schedules,
component procurement commitments, facility requirements, personnel needs, and
other resource requirements, based on our estimates of customer requirements.
The short-term nature of our customers commitments and the possibility of
rapid changes in demand for their products reduce our ability to estimate
accurately the future requirements of those customers. Because many of our
costs and operating expenses are relatively fixed, a reduction in customer
demand can harm our gross margins and operating results.

On occasion, customers may require rapid increases in production, which
can stress our resources and reduce operating margins. Although we have had a
net increase in our manufacturing capacity over the past few years, we may not
have sufficient capacity at any given time to meet all of our customers
demands or to meet the requirements of a specific project.

Our operating results have been materially and adversely affected in the
past as a result of the failure to obtain anticipated orders and deferrals or
cancellations of purchase commitments because of changes in customer
requirements. For example, we have made announcements in the past that sales
would not meet our expectations because of delays in customer programs.

We depend on the market acceptance of the products of our customers.

We do not sell any products to end users. Instead, we design and
manufacture various display product solutions that our customers incorporate
into their products and provide electronic manufacturing services to OEMs. As
a result, our success depends almost entirely upon the widespread market
acceptance of our customers products. Any significant slowdown in the demand
for our customers products would adversely affect our business.

Because our success depends on the widespread market acceptance of our
customers products, we must identify industries that have significant growth
potential and establish relationships with OEMs in those industries. Our
failure to identify potential growth opportunities or establish relationships
with OEMs in those industries would adversely affect our business.

Our dependence on the success of the products of our customers exposes us
to a variety of risks, including the following:



| |  |  | our ability to provide significant design and manufacturing
services for customers on a timely and cost-effective basis;                    
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | our success in maintaining customer satisfaction with our
design and manufacturing services;                                                
|
| |  |  | our ability to match our design and manufacturing capacity
with customer demand and to maintain satisfactory delivery
schedules;            
|
| |  |  | customer order patterns, changes in order mix, and the level
and timing of orders placed by customers that we can complete in a
quarter; and
|
| |  |  | the cyclical nature of the industries and markets we serve.                                                                                 

Our failure to address these risks may cause our sales to decline.

Shortages of components and materials may delay or reduce our sales and
increase our costs.

We rely on a limited number of suppliers for many components used in our
manufacturing and assembly processes. We do not have any long-term supply
agreements. At various times, there have been shortages of some

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of the electronic components that we use and suppliers of some components
have lacked sufficient capacity to meet the demand for these components. Our
inability to obtain sufficient quantities of components and other materials
necessary to produce our displays and to provide our electronic manufacturing
services could result in reduced or delayed sales or lost orders, increased
inventory, and underutilized manufacturing capacity. Any delay in or loss of
sales could adversely impact our operating results. In addition, we may not be
able to pass on component and materials price increases to our customers,
particularly in the case of turnkey manufacturing agreements. We obtain many
of the materials we use in the manufacture of our displays and to provide our
electronic manufacturing services from a limited number of foreign suppliers,
particularly suppliers located in Asia. As a result, we are subject to
increased costs, supply interruptions, and difficulties in obtaining materials.
Our customers also may encounter difficulties or increased costs in obtaining
from others the materials necessary to produce their products into which our
product solutions are incorporated.

We depend on Taiwan-based United Microelectronics Corporation, or UMC, for
the fabrication of ASICs and backplanes related to our microdisplay business.
We do not have a long-term contract with UMC. As a result, UMC is not
obligated to supply us with ASICs or backplanes for any specific period, in any
specific quantity, or at any specific price, except as provided in purchase
orders from time to time. The termination of our arrangements with UMC or its
inability or unwillingness to provide us with the necessary amount or quality
of ASICs or backplanes on a timely basis would adversely affect our ability to
manufacture and ship our microdisplay products until alternative sources of
supply could be arranged. We cannot assure you that we would be able to secure
alternative arrangements.

Materials and components for some of our major programs from time to time
have been subject to allocation because of shortages of these materials and
components. During 1998, we occasionally delayed sales of our LCD modules as a
result of the unavailability of LCD polarizers and IC drivers, or ASICs.
During 1999, we experienced difficulties obtaining our requirements for ASICs
as a result of a worldwide shortage. We also experienced a material supply
interruption in ASICs for a key program in the fourth quarter of 2000. These
shortages resulted in lost sales opportunities. Similar shortages in the
future could have a material adverse effect on our business.

Our operating results may be adversely affected by excess inventory.

We typically purchase components and other materials in anticipation of
customer orders based on customer forecasts. For a variety of reasons, such as
decreased end-user demand for products containing our modules or customer
solutions as for products that we are manufacturing on a contract basis, our
customers may not purchase all of our product solutions or products we have
committed to manufacture for which we have purchased components or other
supplies. In such event, we could attempt to recoup our materials and
manufacturing costs by various means, including returning components to our
suppliers, disposing of excess inventory through other channels, or attempting
to require our OEM customers to purchase or otherwise compensate us for such
excess inventory. These efforts, however, may not be successful. To the
extent we are unsuccessful in recouping our materials and manufacturing costs,
our operating result would be adversely affected and excess inventory would
reduce our working capital.

We must maintain satisfactory manufacturing yields and capacity.

Our inability to maintain high levels of productivity or satisfactory
delivery schedules at our manufacturing facilities in Manila, Beijing,
Washington, Massachusetts, or Arizona would adversely affect our operating
results. The design and manufacture of electronic devices are highly complex
processes that are sensitive to a wide variety of factors, including the level
of contaminants in the manufacturing environment, impurities in the materials
used, and the performance of personnel and equipment. As is typical in the
industry, at times we have experienced lower than anticipated manufacturing
yields and lengthening of delivery schedules. We may encounter lower
manufacturing yields and longer delivery schedules as we expand our electronic
manufacturing services and as we manufacture LCoSmicrodisplays in higher
volumes. In addition, the complexity of manufacturing processes will increase
along with increases in the sophistication of our display modules and other
products we produce.

Any problems with our manufacturing operations could result in the
lengthening of our delivery schedules, reductions in the quality or performance
of our design and manufacturing services, and reduced customer satisfaction.

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Our business depends on new products and technologies.

We operate in rapidly changing industries. Technological advances, the
introduction of new products, and new design and manufacturing techniques could
adversely affect our business unless we are able to adapt to the changing
conditions. As a result, we will be required to expend substantial funds for
and commit significant resources to the following:



| |  |  | continue research and development activities on existing and potential product solutions;                          
| | - |  | -------------------------------------------------------------------------------------------------------------------
|
| |  |  | engage additional engineering and other technical personnel;                                                       
|
| |  |  | purchase advanced design, production, and test equipment;                                                          
|
| |  |  | maintain and enhance our technological capabilities;                                                               
|
| |  |  | develop and market manufacturing services that meet changing customer needs;                                       
|
| |  |  | anticipate or respond to technological changes in
manufacturing processes on a cost-effective and timely basis; and
|
| |  |  | expand our manufacturing capacity.                                                                                 

Our future operating results will depend to a significant extent on our
ability to continue to provide new product solutions and electronic
manufacturing services that compare favorably on the basis of time to
introduction, cost, and performance with the design and manufacturing
capabilities of OEMs and competitive third-party suppliers and technologies.
Our success in attracting new customers and developing new business depends on
various factors, including the following:



| |  |  | utilization of advances in technology;                                                
| | - |  | --------------------------------------------------------------------------------------
|
| |  |  | innovative development of new solutions for customer products;                        
|
| |  |  | efficient and cost-effective services; and                                            
|
| |  |  | timely completion of the design and manufacture of new products and product solutions.

Our efforts to develop new technologies may not result in commercial success.

Our efforts with respect to incorporating new technologies in our products
may not result in customer or widespread market acceptance. Some or all of
those technologies may not successfully make the transition from the
development stage to cost-effective production as a result of technology
problems, competitive cost issues, yield problems, and other factors. Even
when we successfully complete an introduction with respect to a particular
technology, our customers may determine not to introduce or may terminate
products utilizing the technology for a variety of reasons, including the
following:



| |  |  | difficulties with other suppliers of components for the products;
| | - |  | -----------------------------------------------------------------
|
| |  |  | superior technologies developed by our competitors;              
|
| |  |  | price considerations;                                            
|
| |  |  | lack of anticipated or actual market demand for the products; and
|
| |  |  | unfavorable comparisons with products introduced by others.      

The nature of our business requires us to make capital expenditures and
investments for new technologies. For example, our capital acquisition value
of the assets, including intangibles such as tooling, licenses, and patents for
LCoSmicrodisplays, currently our largest research and development effort, was
$27.4 million through December 31, 2002. To facilitate the development of our
LCoSmicrodisplay products, we also made an equity investment of $3.8 million
in Inviso, Inc., which we had to write off in 2001 as a result of the closing
of those operations. In 2002, we purchased all of the technology of Inviso for
$780,000. In addition, we purchased assets and technology of the former Light
Valve business unit of National Semiconductor Corporation for approximately
$3.6 million during

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1999 and the technology and certain assets of Zight Corporation for
approximately $2.6 million in early 2002. We also invested $1.25 million in a
microdisplay component related start-up company, Silicon Bandwidth, Inc.,
during 2001 and $5.1 million in ColorLink, Inc., another private company
focusing on a key component for LCoSmicrodisplay light engines during 2002.
We may be required to make similar investments and acquisitions in the future
to maintain or enhance our ability to offer technological solutions.

Significant expenditures relating to one or more new technologies,
especially LCoSmicrodisplays, that ultimately prove to be unsuccessful for any
reason could have a material adverse effect on us. In addition, any
investments or acquisitions made to enhance our technologies may prove to be
unsuccessful.

Our inability to maintain our technological expertise in design and
manufacturing processes would adversely affect our competitive condition.

Our success depends on our ability to develop and provide design and
manufacturing services that meet the changing needs of our customers. This
requires us to anticipate and respond to technological changes in design and
manufacturing processes in a cost-effective and timely manner. To achieve this
goal, we continually evaluate the advantages and feasibility of new product
design and manufacturing processes. We cannot assure you that we will be
successful.

We face risks associated with international operations.

Our manufacturing operations in Manila and Beijing and our sales and
distribution operations in Europe and Asia create a number of logistical and
communications challenges. Our international operations also expose us to
various economic, political, and other risks, including the following:



| |  |  | management of a multi-national organization;                                                             
| | - |  | ---------------------------------------------------------------------------------------------------------
|
| |  |  | compliance with local laws and regulatory requirements as
well as changes in those laws and requirements;
|
| |  |  | imposition of restrictions on currency conversion or the transfer of funds;                              
|
| |  |  | transportation delays or interruptions and other effects of less developed infrastructures;              
|
| |  |  | foreign exchange rate fluctuations;                                                                      
|
| |  |  | difficulties in staffing and managing foreign personnel and diverse cultures;                            
|
| |  |  | employment and severance issues;                                                                         
|
| |  |  | overlap of tax issues;                                                                                   
|
| |  |  | tariffs and duties;                                                                                      
|
| |  |  | possible employee turnover or labor unrest;                                                              
|
| |  |  | lack of developed infrastructure;                                                                        
|
| |  |  | the burdens and costs of compliance with a variety of foreign laws; and                                  
|
| |  |  | political or economic instability in countries in which we conduct business.                             

Changes in policies by the United States or foreign governments resulting
in, among other things, increased duties, higher taxation, currency conversion
limitations, restrictions on the transfer or repatriation of funds, limitations
on imports or exports, or the expropriation of private enterprises also could
have a material adverse effect on us. Any actions by our host countries to
reverse policies that encourage foreign investment or foreign trade also could
adversely affect our operating results. In addition, U.S. trade policies, such
as most favored nation status and trade preferences for certain Asian
nations, could affect the attractiveness of our services to our U.S. customers.

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We depend on our manufacturing operations.

We depend on our manufacturing operations in Arizona, Washington,
Massachusetts, Manila, and China. Our Arizona facility and its high-volume
LCoSmicrodisplay manufacturing line are critical to our success in LCoS
microdisplays. We intend, at least initially, to produce all of our LCoS
microdisplays on this dedicated line. This facility also houses our principal
research, development, engineering, design, and managerial operations for LCoS
microdisplays. Any event that causes a disruption of the operation of this
facility for even a relatively short period of time would adversely affect our
ability to provide both technical and manufacturing support for our customers,
especially our microdisplay customers.

Any disruption or termination of our manufacturing operations in Manila or
air transportation with the Philippines, even for a relatively short period of
time, would adversely affect our operations. The Philippines have been subject
to volcanic eruptions, typhoons, and substantial civil disturbances, including
attempted military coups against the government, since we commenced operations
there in 1986. Cumulative capital investments in the Philippines amounted to
approximately $18.3 million through December 31, 2002. We believe that our
manufacturing operations in Manila constitute one of our most important
resources and that it would be difficult to replace the low-cost,
high-performance facility or the highly trained production staff in the event
of the disruption or termination of our manufacturing operations there.

Cumulative capital investments in China amounted to approximately $13.2
million through December 31, 2002. Our operations and assets in China are
subject to significant political, economic, legal, and other uncertainties in
China. The Chinese government recently has been pursuing economic reform
policies, including the encouragement of foreign trade and investment and
greater economic decentralization. The Chinese government, however, may not
continue to pursue these policies, may not successfully pursue these policies,
or may significantly alter these policies from time to time. China currently
does not have a comprehensive and highly developed system of laws, particularly
with respect to foreign investment activities and foreign trade. Enforcement
of existing and future laws and contracts is uncertain, and implementation and
interpretation of laws may be inconsistent. As the Chinese legal system
develops, the passage of new laws, changes in existing laws, and the preemption
of local regulations by national laws may adversely affect us. We also could
be adversely affected by a number of other factors, including the following:



| |  |  | the imposition of austerity measures intended to reduce
inflation;                                                                                                       
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | inadequate development or maintenance of infrastructure,
including the unavailability of adequate power and water supplies,
transportation, raw materials, and parts; and
|
| |  |  | a deterioration of the general political, economic, or social
environment in China.                                                                                      

Although China recently joined the World Trade Organization, we cannot be
certain whether or to what extent trade relations with China will continue to
improve. Any developments that adversely affect trade relations between the
United States and China in the future could adversely affect us by increasing
the cost to U.S. customers of products manufactured by us in China.

We face risks associated with international trade and currency exchange.

Political and economic conditions abroad may adversely affect our foreign
manufacturing and sales operations. Protectionist trade legislation in either
the United States or foreign countries, such as a change in the current tariff
structures, export or import compliance laws, or other trade policies, could
adversely affect our ability to manufacture or sell products and product
solutions in foreign markets and to purchase materials or equipment from
foreign suppliers.

While we transact business predominantly in U.S. dollars and bill and
collect most of our sales in U.S. dollars, we collect a portion of our revenue
in non-U.S. currencies, such as the Chinese renminbi. In the future, customers
increasingly may make payments in non-U.S. currencies, such as the Euro. In
addition, we account for a portion of our costs, such as payroll, rent, and
indirect operating costs, in non-U.S. currencies, including Philippine pesos,
British pounds sterling, and Chinese renminbi.

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Fluctuations in foreign currency exchange rates could affect our cost of
goods and operating margins and could result in exchange losses. In addition,
currency devaluation can result in a loss to us if we hold deposits of that
currency. The Philippine peso suffered a major devaluation in late 1997, and
the Chinese renminbi has experienced significant devaluation against most major
currencies in recent years. Hedging foreign currencies can be difficult,
especially if the currency is not freely traded. We cannot predict the impact
of future exchange rate fluctuations on our operating results.

The risks described above are particularly important since sales outside
North America represented 83.2% of our net sales in 2001 and 85.1% of our net
sales in 2002. Sales in foreign markets, primarily Europe and China, to OEMs
based in the United States accounted for almost all of our international sales
in both of these periods.

Variability of customer requirements may adversely affect our operating
results.

Custom manufacturers for OEMs must provide increasingly rapid product
turnaround and respond to ever-shorter lead times. A variety of conditions,
both specific to individual customers and generally affecting the demand for
their products, may cause customers to cancel, reduce, or delay orders.
Cancellations, reductions, or delays by a significant customer or by a group of
customers could adversely affect our business. On occasion, customers require
rapid increases in production, which can strain our resources and reduce our
margins. Although we have increased our manufacturing capacity, we may lack
sufficient capacity at any given time to meet our customers demands if their
demands exceed anticipated levels.

Our operating results have significant fluctuations.

In addition to the variability resulting from the short-term nature of our
customers commitments, other factors contribute to significant periodic and
seasonal quarterly fluctuations in our results of operations. These factors
include the following:



| |  |  | the timing of orders;                                                                      
| | - |  | -------------------------------------------------------------------------------------------
|
| |  |  | the volume of orders relative to our capacity;                                             
|
| |  |  | product introductions and market acceptance of new products or new generations of products;
|
| |  |  | evolution in the life cycles of customers products;                                       
|
| |  |  | timing of expenditures in anticipation of future orders;                                   
|
| |  |  | effectiveness in managing manufacturing processes and costs;                               
|
| |  |  | changes in cost and availability of labor and components;                                  
|
| |  |  | introduction and market acceptance of our customers products;                             
|
| |  |  | changes in economic conditions generally or in our customers markets;                     
|
| |  |  | product mix;                                                                               
|
| |  |  | pricing and availability of competitive products and services; and                         
|
| |  |  | changes or anticipated changes in economic conditions.                                     

Accordingly, you should not rely on the results of any past periods as an
indication of our future performance. It is likely that in some future period,
our operating results may be below expectations of public market analysts or
investors. If this occurs, our stock price may decline.

Products we manufacture may contain design or manufacturing defects, which
could result in reduced demand for our services and liability claims against
us.

We manufacture products to our customers specifications, which are highly
complex and may at times contain design or manufacturing errors or failures.
Any defects in the products we manufacture, whether caused by a design,
manufacturing, or component failure or error, may result in delayed shipments
to customers or reduced or

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cancelled customer orders. If these defects occur in large quantities or
too frequently, our business reputation also may be impaired. In addition,
these defects may result in liability claims against us.

We must effectively manage our growth.

The failure to manage our growth effectively could adversely affect our
operations. We have increased the number of our manufacturing and design
programs and plan to expand further the number and diversity of our programs in
the future. Our ability to manage our planned growth effectively will require
us to



| |  |  | enhance our operational, financial, and management systems;                                                                                                                                              
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | expand our facilities and equipment; and                                                                                                                                                                 
|
| |  |  | successfully hire, train, and motivate additional employees,
including the technical personnel necessary to operate our
production facilities in Arizona, Washington, Massachusetts, Manila,
and Beijing.

The expansion and diversification of our product and customer base may
result in increases in our overhead and selling expenses. We also may be
required to increase staffing and other expenses as well as our expenditures on
capital equipment and leasehold improvements in order to meet the anticipated
demand of our customers. Customers, however, generally do not commit to firm
production schedules for more than a short time in advance. Any increase in
expenditures in anticipation of future orders that do not materialize would
adversely affect our profitability. Customers also may require rapid increases
in design and production services that place an excessive short-term burden on
our resources.

We depend on key personnel.

Our development and operations depend substantially on the efforts and
abilities of our senior management and technical personnel. The competition
for qualified management and technical personnel is intense. The loss of
services of one or more of our key employees or the inability to add key
personnel could have a material adverse effect on us. Although we maintain
non-competition and nondisclosure covenants with certain key personnel, we do
not have any fixed-term agreements with, or key person life insurance covering,
any officer or employee.

We must protect our intellectual property, and others could infringe on or
misappropriate our rights.

We believe that our continued success depends in part on protecting our
proprietary technology. Third parties could claim that we are infringing their
patents or other intellectual property rights. In the event that a third party
alleges that we are infringing its rights, we may not be able to obtain
licenses on commercially reasonable terms from the third party, if at all, or
the third party may commence litigation against us. The failure to obtain
necessary licenses or other rights or the institution of litigation arising out
of such claims could materially and adversely affect us.

We rely on a combination of patent, trade secret, and trademark laws,
confidentiality procedures, and contractual provisions to protect our
intellectual property. We seek to protect certain of our technology under
trade secret laws, which afford only limited protection. We face risks
associated with our intellectual property, including the following:



| |  |  | pending patent applications may not be issued;                                                                                                     
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | intellectual property laws may not protect our intellectual property rights;                                                                       
|
| |  |  | third parties may challenge, invalidate, or circumvent any patent issued to us;                                                                    
|
| |  |  | rights granted under patents issued to us may not provide competitive advantages to us;                                                            
|
| |  |  | unauthorized parties may attempt to obtain and use
information that we regard as proprietary despite our efforts to
protect our proprietary rights;
|
| |  |  | others may independently develop similar technology or design
around any patents issued to us; and                                                 

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| |  |  | effective protection of intellectual property rights may be
limited or unavailable in some foreign countries, such as China, in
which we operate.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------

We may not be able to obtain effective patent, trademark, service mark,
copyright, and trade secret protection in every country in which we sell our
products. We may find it necessary to take legal action in the future to
enforce or protect our intellectual property rights or to defend against claims
of infringement. Litigation can be very expensive and can distract our
managements time and attention, which could adversely affect our business. In
addition, we may not be able to obtain a favorable outcome in any intellectual
property litigation.

The market price of our common stock may be volatile.

The market price of our common stock has been extremely volatile. Our
stock price increased dramatically during the three-year period ended December
31, 1994, but declined significantly during 1995 and 1996. Our stock price
increased again during 1997, but declined significantly in 1998. Our stock
price again increased significantly during 1999 and in early 2000, but suffered
a major decline in the second half of 2000. The stock declined again in 2001
and 2002. The trading price of our common stock in the future could continue
to be subject to wide fluctuations in response to various factors, including
the following:



| |  |  | variations in our quarterly operating results;                                                                    
| | - |  | ------------------------------------------------------------------------------------------------------------------
|
| |  |  | actual or anticipated announcements of technical innovations
or new product developments by us or our competitors;
|
| |  |  | changes in analysts estimates of our financial performance;                                                      
|
| |  |  | general conditions in the electronics industry; and                                                               
|
| |  |  | worldwide economic and financial conditions.                                                                      

In addition, the stock market has experienced extreme price and volume
fluctuations that have particularly affected the market prices for many
high-technology companies and that often have been unrelated to the operating
performance of these companies. These broad market fluctuations and other
factors may adversely affect the market price of our common stock.

Adverse trends in the electronics industry may adversely affect our operating
results.

Our business depends on the electronics industry, which is subject to
rapid technological change, short product life cycles, and margin pressures.
In addition, the electronics industry historically has been cyclical and
subject to significant downturns characterized by diminished product demand,
accelerated erosion of average selling prices, and production over-capacity.
We seek to reduce our exposure to industry downturns and cyclicality by
providing design and production services for leading companies in a variety of
rapidly expanding segments of the electronics industry. Despite these efforts,
economic conditions affecting the electronics industry in general or our major
customers may adversely affect our operating results.

We must finance the growth of our business and the development of new products
and services.

To remain competitive, we must continue to make significant investments in
product development, equipment, and facilities. As a result of the increase in
fixed costs and operating expenses related to these capital expenditures, our
failure to increase sufficiently our net sales to offset these increased costs
would adversely affect our operating results.

From time to time, we may seek additional equity or debt financing to
provide for the capital expenditures required to maintain or expand our design
and production facilities and equipment. We cannot predict the timing or
amount of any such capital requirements at this time. If such financing is not
available on satisfactory terms, we may be unable to expand our business or to
develop new business at the rate desired and our operating results may suffer.
Debt financing increases expenses and must be repaid regardless of operating
results. Equity financing could result in additional dilution to existing
stockholders.

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Potential strategic alliances may not achieve their objectives.

We have entered into various strategic alliances, such as our alliances
with OSRAM Opto Semiconductors for OLEDs, and we plan on entering into other
similar types of alliances in the future. Among other matters, we will explore
strategic alliances designed to enhance or complement our technology or to work
in conjunction with our technology; to increase our manufacturing capacity; to
provide necessary know-how, components, or supplies; and to develop, introduce,
and distribute products and services utilizing our technology and know-how.
Any strategic alliances may not achieve their strategic objectives, and parties
to our strategic alliances may not perform as contemplated.

We could be required to expend substantive resources to comply with
governmental regulations.

Our operations are subject to certain federal, state, and local regulatory
requirements relating to environmental, waste management, health, and safety
matters. We believe we operate in substantial compliance with all applicable
requirements. There can be no assurance, however, that material costs and
liabilities will not arise from complying with these or from new, modified, or
more stringent requirements. In addition, our past, current, or future
operations may give rise to claims of exposure by employees or the public or to
other claims or liabilities relating to environmental, waste management, or
health and safety concerns.

Change in control provisions may adversely affect existing stockholders.

Our restated certificate of incorporation and the Delaware General
Corporation Law contain provisions that may have the effect of making more
difficult or delaying attempts by others to obtain control of our company, even
when these attempts may be in the best interests of stockholders. Our restated
certificate also authorizes the board of directors, without stockholder
approval, to issue one or more series of preferred stock, which could have
voting and conversion rights that adversely affect or dilute the voting power
of the holders of common stock. Delaware law also imposes conditions on
certain business combination transactions with interested stockholders.

We have also adopted a stockholders rights plan intended to encourage
anyone seeking to acquire our company to negotiate with our board of directors
prior to attempting a takeover. While the plan was designed to guard against
coercive or unfair tactics to gain control of our company, the plan may have
the effect of making more difficult or delaying any attempts by others to
obtain control of our company.

We do not pay cash dividends.

We have never paid any cash dividends on our common stock and do not
anticipate that we will pay cash dividends in the foreseeable future. Instead,
we intend to apply earnings to the expansion and development of our business.




ITEM 2. PROPERTIES

We own and occupy an approximately 97,000 square foot facility in Tempe,
Arizona, which houses our U.S.-based manufacturing operations and our research,
development, engineering, design, and corporate functions. We entered into a
ground lease for this facility that extends through March 31, 2069, subject to
renewal and purchase options as well as early termination provisions. Costs to
initially construct, furnish, and equip the Tempe facility were approximately
$24.0 million.

We lease an approximately 65,000 square foot manufacturing facility in
Camelray Industrial Park, Barangay Tulo, Calamba, Laguna, the Philippines with
an option to purchase the premises. The lease expires in 2010.

We own and occupy an approximately 46,000 square foot facility in Beijing,
China, including 29,000 square feet of manufacturing space. We constructed
this facility on property that we have purchased on a long-term land use
contract. Costs to construct, furnish, and equip the Beijing facility were
approximately $10.9 million.

We lease an approximately 32,000 square foot manufacturing facility in
Redmond, Washington. The lease expires in 2007. In addition, in Redmond,
Washington, we also lease two other facilities. One facility is a 30,000
square foot building, which we have used for final product assembly (box
build) and logistics operations. This lease

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expires in 2006. The third
building that we lease in Redmond, Washington handles returns, repairs, and
storage and is approximately 33,000 square feet. That lease expires in 2006.

We lease approximately 21,000 square feet of manufacturing and office
space in Marlboro, Massachusetts, where we maintain a business unit focusing on
our ruggedized monitor business. That lease expires in 2004

We lease approximately 7,000 square feet of space in Boulder, Colorado,
where we maintain a business unit focusing on personal microdisplay systems and
comprised of former Zight Corporation employees. This lease has no long-term
commitments and is renewed each month.

We lease approximately 3,500 square feet of office and warehouse space in
Swindon, United Kingdom, where we maintain our European administrative offices
and a distribution warehouse.




ITEM 3. LEGAL PROCEEDINGS

There are no legal proceedings to which we are a party or to which any of
our properties are subject, other than routine litigation incident to our
business that is covered by insurance or an indemnity or that we do not expect
to have a material adverse effect on our company. It is possible, however,
that we could incur claims for which we are not insured or that exceed the
amount of our insurance coverage.




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.




PART II




ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock has been listed on the New York Stock Exchange under the
symbol TFS since December 29, 1994. The following table sets forth the
quarterly high and low sales prices of our common stock as reported on the New
York Stock Exchange for the periods indicated:

|      |                                        |  |      |       |     |  |   |       | 
|----- | -------------------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|      |                                        |  | High |       | Low
|      |                                        |  |      |       |    
|2001: |                                        |  |      |       |     |  |   |      
|      | First Quarter                          |  | $    | 27.11 |     |  | $ | 11.74 | 
|      | Second Quarter                         |  |      | 18.35 |     |  |   | 10.68 | 
|      | Third Quarter                          |  |      | 23.85 |     |  |   | 14.18 | 
|      | Fourth Quarter                         |  |      | 21.74 |     |  |   | 14.60 | 
|2002: |                                        |  |      |       |     |  |   |      
|      | First Quarter                          |  | $    | 17.80 |     |  | $ | 12.19 | 
|      | Second Quarter                         |  |      | 15.85 |     |  |   | 9.05  | 
|      | Third Quarter                          |  |      | 10.73 |     |  |   | 4.55  | 
|      | Fourth Quarter                         |  |      | 7.45  |     |  |   | 3.62  | 
|2003: |                                        |  |      |       |     |  |   |      
|      | First Quarter (through March 21, 2003) |  | $    | 6.34  |     |  | $ | 3.67  | 

As of March 21, 2003, there were approximately 652 holders of record of
our common stock. The closing sale price of our common stock on the New York
Stock Exchange on March 21, 2003 was $5.55 per share.

Our policy is to retain earnings to provide funds for the operation and
expansion of our business. We have not paid cash dividends on our common stock
and do not anticipate that we will do so in the foreseeable future.
Furthermore, our credit facility with Comerica Bank does not permit us to pay
dividends without the consent of
Comerica Bank. The payment of dividends in the future will depend on our
growth, profitability, financial condition, and other factors that our board of
directors may deem relevant.

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ITEM 6. SELECTED FINANCIAL DATA

The selected historical financial data presented below are derived from
our consolidated financial statements. The financial statements from 2002 have
been audited by Deloitte & Touche LLP, independent auditors. The selected
financial data should be read in conjunction with Item 7, Managements
Discussion and Analysis of Financial Condition and Results of Operations and
the Consolidated Financial Statements and the Notes thereto included elsewhere
in this report. All share amounts and per share data have been adjusted to
reflect the four-for-three split of our common stock effected in December 1999
and the three-for-two split of our common stock effected in May 2000.

|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |        |  
|---------------------------------------------------- | -------------------------------------- | - | ------------------------------------- | ------ | ---- | - | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- | - | - | ------- | ------ | -
|                                                     |                                        |   | Years Ended December 31,             
|                                                     |                                        |   |                                      
|                                                     |                                        |   | 1998                                  |        | 1999 |   | 2000    |         | 2001 |   | 2002   
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |        
|                                                     |                                        |   | (in thousands, except per share data)
|Consolidated Statements of Operations Data:          |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|Net sales                                            |                                        | $ | 95,047                                |        |      | $ | 147,408 |         |      | $ | 160,684 |         |  | $ | 119,136 |         |   | $ | 88,026  |       
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|Costs and expenses:                                  |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|                                                     | Cost of sales                          |   |                                       | 76,149 |      |   |         | 117,583 |      |   |         | 124,724 |  |   |         | 121,514 |   |   |         | 85,133 |  
|                                                     | Selling, general, and administrative   |   |                                       | 7,334  |      |   |         | 11,170  |      |   |         | 9,501   |  |   |         | 10,130  |   |   |         | 11,324 |  
|                                                     | Research, development, and engineering |   |                                       | 7,159  |      |   |         | 8,745   |      |   |         | 13,295  |  |   |         | 17,618  |   |   |         | 17,968 |  
|                                                     | Write-down
of assets held for sale     |   |                                       |       |      |   |         |        |      |   |         |        |  |   |         |        |   |   |         | 4,545  |  
|                                                     | Amortization of customer lists         |   |                                       |       |      |   |         |        |      |   |         |        |  |   |         |        |   |   |         | 256    |  
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|                                                     |                                        |   | 90,642                                |        |      |   | 137,498 |         |      |   | 147,520 |         |  |   | 149,262 |         |   |   | 119,226 |       
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|Operating income (loss)                              |                                        |   | 4,405                                 |        |      |   | 9,910   |         |      |   | 13,164  |         |  |   | (30,126 | )       |   |   | (31,200 | )     
|Other income (expense), net                          |                                        |   | (42                                   | )      |      |   | (18     | )       |      |   | 7,184   |         |  |   | 3,450   |         |   |   | 3,492   |       
|Minority interest in loss of consolidated subsidiary |                                        |   |                                      |        |      |   |        |         |      |   |        |         |  |   | 167     |         |   |   | 84      |       
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|Income (loss) before income taxes                    |                                        |   | 4,363                                 |        |      |   | 9,892   |         |      |   | 20,348  |         |  |   | (26,509 | )       |   |   | (27,624 | )     
|Provision for (benefit from) income taxes            |                                        |   | 1,773                                 |        |      |   | 2,968   |         |      |   | 5,514   |         |  |   | (8,745  | )       |   |   | (10,653 | )     
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|Net income (loss)                                    |                                        | $ | 2,590                                 |        |      | $ | 6,924   |         |      | $ | 14,834  |         |  | $ | (17,764 | )       |   | $ | (16,971 | )     
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|Earnings (loss) per common share:                    |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|                                                     | Basic                                  |   | $                                     | 0.17   |      |   | $       | 0.44    |      |   | $       | 0.73    |  |   | $       | (0.83   | ) |   | $       | (0.79  | )
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|                                                     | Diluted                                |   | $                                     | 0.17   |      |   | $       | 0.43    |      |   | $       | 0.69    |  |   | $       | (0.83   | ) |   | $       | (0.79  | )
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|Weighted average number of common shares:            |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|                                                     | Basic                                  |   |                                       | 15,277 |      |   |         | 15,563  |      |   |         | 20,457  |  |   |         | 21,401  |   |   |         | 21,465 |  
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       
|                                                     | Diluted                                |   |                                       | 15,604 |      |   |         | 16,005  |      |   |         | 21,636  |  |   |         | 21,401  |   |   |         | 21,465 |  
|                                                     |                                        |   |                                       |        |      |   |         |         |      |   |         |         |  |   |         |         |   |   |         |       

|                                                      |  |                |        |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|----------------------------------------------------- |  | -------------- | ------ | ---- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                                      |  | December 31,  
|                                                      |  |               
|                                                      |  | 1998           |        | 1999 |  | 2000 |         | 2001 |  | 2002
|                                                      |  |                |        |      |  |      |         |      |  |     
|                                                      |  | (in thousands)
|Consolidated Balance Sheet Data:                      |  |                |        |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|Working capital                                       |  | $              | 24,825 |      |  | $    | 60,853  |      |  | $    | 194,492 |  |  | $ | 169,123 |  |  | $ | 107,885 | 
|Total assets                                          |  |                | 77,904 |      |  |      | 126,930 |      |  |      | 267,843 |  |  |   | 245,888 |  |  |   | 222,694 | 
|Notes payable to banks, term loans
and long-term debt |  |                | 8,095  |      |  |      |        |      |  |      | 2,706   |  |  |   | 2,706   |  |  |   | 2,734   | 
|Stockholders equity                                  |  |                | 51,096 |      |  |      | 101,220 |      |  |      | 242,002 |  |  |   | 223,944 |  |  |   | 205,668 | 




ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT RESULTS

The statements contained in this report on Form 10-K that are not purely
historical are forward-looking statements within the meaning of applicable
securities laws. Forward-looking statements include statements regarding our
expectations, anticipation, intentions, beliefs, or strategies
regarding the future. Forward-looking statements also include statements
regarding revenue, margins, expenses, and earnings analysis for fiscal 2003 and
thereafter; technological innovations; future products or product development;
our product development strategies; potential acquisitions or strategic
alliances; the success of particular product or marketing programs; the amounts
of revenue generated as a result of sales to significant customers; and
liquidity and anticipated cash needs and availability. All forward-looking
statements included in this report are based on information available to us as

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of the filing date of this report, and we assume no obligation to update any
such forward-looking statements. Our actual results could differ materially
from the forward-looking statements. Among the factors that could cause actual
results to differ materially are the factors discussed in Item 1, Business 
Risk Factors.

Overview

We offer advanced design and manufacturing services to original equipment
manufacturers, commonly referred to as OEMs. We have two business divisions,
each reportable as a segment. The first segment is referred to as the
Integrated Systems and Displays division. In that division, we focus on display
products and our electronic manufacturing services. We specialize in custom and
standard display modules utilizing various display technologies, including
liquid crystal displays, or LCDs, organic light emitting displays, or OLEDs,
and cathode ray tubes, or CRTs. Our display modules are of varying sizes and
have varying levels of integration. At a minimum, each display module includes
a display, a custom driver, and a flexible connector. We also provide
ruggedized and customized monitors. We also provide value-added services, which
increase our competitiveness, by assembling additional components onto the
module based upon the specific needs of the customer. These additional
components may include such items as keypads, microphones, speakers, light
guides, and optics. Late in 2002, we expanded the value-added manufacturing
services we provide in the ISD division through our acquisition of ETMA
Corporation, described below. As a result of that acquisition, we now provide
printed circuit board assembly, or PCBA, and box build capabilities to
customers, even in products that do not need displays.

In our second business segment, referred to as the Microdisplay division,
we offer a range of LCoSproduct solutions with different levels of integration
from individual imagers to optical light engines. The initial target markets
for our LCoSmicrodisplay products are large screen television sets, front
projectors, and near-to-eye or personal display system applications.

Substantially all of our sales are in our ISD division. In the past
several years, we derived our revenue principally from major OEMs, with more
than 75% of our net sales in 2000, 2001, and 2002 from the mobile handset
market. As a result of the acquisition of ETMA and the expected reduction in
Motorola business, we expect our revenue from the handset market to drop to
below 20% in 2003. When we win a custom program, our customers occasionally pay
a portion of our nonrecurring engineering expenses to defray the costs of
custom design, as well as all or a portion of the costs of nonrecurring tooling
for custom or specialized components. The typical design program life cycle of
a custom-designed display module is three to fifteen months and includes
technical design, prototyping, pilot manufacturing, and high-volume
manufacturing. The cycle is shorter in the manufacturing services business
where no display is involved and where the design has already been done by the
OEM customer. Until 2001, our strategy in our display business was to seek
large-volume programs from major OEMs. In that situation, the minimum
production quantity for a display module typically approximates 100,000 units
per year, although the production rate for some programs has been higher than
100,000 units per week. In 2002, we re-focused our strategy on lower-volume
programs with potentially higher gross margins. We re-focused our strategy
because some OEMs with high-volume programs began to expect to purchase display
modules for less than industry costs. Early in 2003, we licensed the standard
product line of Data International. The standard products of Data International
that we sell will fit into the strategy of lower-volume programs. The selling
price of our products sold in the ISD division now range from between $3 and
$4,300 per unit.

We experienced substantial growth from 1993 through 1995, primarily as a
result of sales to OEMs in the wireless communications industry, which grew
substantially during that period. During that period, our primary customer in
the wireless communications industry was Motorola. We experienced substantial
growth in 1999 and 2000, but our sales substantially declined in 2001 as a
result of the world-wide economic slowdown. Motorola and its subcontractors
accounted for 63.6% of our sales in 1998, 86.1% in 1999, 86.9% in 2000, 85.4%
in 2001, and 76.9% in 2002. As a result of our change in strategy regarding
high-volume display programs, discussed above, none of our design wins in 2001
and 2002 have been with the handset group at Motorola. Consequently, we expect
total Motorola business to decline sharply in 2003. In the third quarter of
2002, Motorola was 77.7% of our business. In the fourth quarter of 2002,
Motorola was 54.6% of our business. In the first quarter of 2003, we expect
Motorola to be less than 20% of our business. For all of 2003, we expect
Motorola to account for less than 10% of our revenue.

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During the past several years, we have experienced seasonal quarterly
fluctuations in our net sales as our OEM customers developed retail products
with shorter product life cycles and phased out older programs early in the
year following holiday sales. Therefore, as compared with the fourth quarter
of a calendar year, sales are usually lower in the following quarter. Although
that pattern of first quarter softness is expected in 2003, our revenue is not
actually expected to decline because of the ETMA acquisition that occurred in
December 2002.

In all of our businesses, we recognize revenue related to product
shipments when persuasive evidence of an arrangement exists, delivery of the
product or service has occurred, the fee is fixed or determinable, and
collectability is probable. These conditions are met at the time we either
ship products to customers or when they are received by the customer, depending
on when title and risk of loss transfers to the customer. We recognize revenue
related to nonrecurring engineering and nonrecurring tooling after service has
been rendered. This can be determined based upon completion of agreed upon
milestones or deliverables.

Several factors impact our gross margins, including manufacturing
efficiencies, product mix, product differentiation, product uniqueness,
inventory management, and volume pricing.

In the past, we used our own front-end LCD production line in Tempe,
Arizona for the manufacture of more technologically complex and custom
high-volume LCDs. We also purchased LCDs from third parties to provide us an
alternate source and to ensure available capacity. In order to take advantage
of lower labor costs, we traditionally shipped LCDs to our facilities in
Manila, the Philippines, or Beijing, China, for assembly into modules.

During 2001, we decided to shut down and move our front-end manufacturing
LCD line from Arizona to Asia. We now purchase all of our LCDs from third
parties, although we sometimes purchase partially completed LCDs and complete
the back-end operations on those LCDs in Manila, as described below. During
2002, we signed a Cooperative Agreement with a Chinese company under which we
agreed to sell the equipment used in our front-end LCD line and establish a
supply agreement. Under the terms of the Cooperative Agreement, in exchange for
our front-end LCD line, we will receive $3.0 million in cash, favorable LCD
glass pricing, and flexible yet assured manufacturing capacity from this
strategic partner. In the second quarter of 2002, as a result of signing the
Cooperative Agreement, we realized a charge of $4.5 million for the write-down
on the LCD equipment to be sold to the Chinese company. This charge was
reported as a separate line item in operating expense. In connection with the
Cooperative Agreement, we received $2.1 million in 2002, all of which was
applied against the $3.0 million sales price and recorded as a reduction in the
carrying value of the LCD equipment held for sale. The sale of the equipment
is expected to be completed in 2003.

In Tempe, Arizona, we continue to manufacture all of our LCoS
microdisplays on our high-volume liquid crystal on silicon manufacturing line.
In addition, we do all testing and assembly into LCoSmodules in Tempe.

In Redmond, Washington, we provide engineering support, automated printed
circuit board assembly, in-circuit and functional testing, systems integration
and box build, complete supply chain management, and turnkey packaging and
fulfillment services.

In Marlboro, Massachusetts, we provide aftermarket customization of CRT
and LCD monitors.

In Manila, we assemble displays into modules and perform certain back-end
LCD processing operations. We conduct all of our operations in Manila at our
own factory where we employ our own employees. Until April 2002, our back-end
LCD processing operations were conducted in Manila through a third-party
subcontract manufacturer. Since that date, however, the Manila back-end LCD
processing has been performed in our own facility. The new facility is located
in a special Philippines economic zone (PEZA), which allows us to take
advantage of certain tax benefits.

In Beijing, we also assemble displays into modules. We conduct our
display module operations in Beijing through our wholly owned foreign
subsidiary at a facility we own. We also employ all of our own employees in
Beijing.

Selling, general, and administrative expense consists principally of
administrative and selling costs; salaries, commissions, and benefits to
personnel; and related facility costs. We make substantially all of our sales

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directly to OEMs through a sales force that consists of both direct
technical sales persons and a representative network. As a result, there is no
material cost of distribution in our selling, general, and administrative
expense. In addition, we have recently incurred substantial marketing and
administrative expenses in connection with our LCoSmicrodisplay business.

Research, development, and engineering expense consists principally of
salaries and benefits to scientists, design engineers, and other technical
personnel, related facility costs, process development costs, and various
expenses for projects, including new product development. Research,
development, and engineering expense continues to increase as we develop new
display products and technologies, especially LCoSmicrodisplays.

Since 1997, we have been working on the development of LCoSmicrodisplays.
In 1997, we entered into a strategic alliance with National Semiconductor
Corporation for the development of LCoSmicrodisplay products. Under that
alliance, National Semiconductor focused on the silicon technologies needed for
microdisplays, and we focused on the liquid crystal technologies. In 1999,
National Semiconductor decided to close its microdisplay business unit. In
connection with that closing, in July 1999, we purchased certain assets and
licensed silicon technologies from National Semiconductor relating to LCoS
microdisplays. We paid approximately $3.0 million in cash and issued warrants
to purchase 140,000 shares of our common stock in the transaction, which valued
the transaction at approximately $3.6 million. No additional payments are
required under the licenses. We also hired several key technical employees of
National Semiconductor to assist in the implementation of the acquired
technologies.

In April 1998, we entered into a strategic relationship with Inviso, Inc.,
a privately held company with numerous patents and proprietary technology
related to microdisplay development. We acquired a minority equity interest in
Inviso for approximately $3.3 million. In March 2000, we acquired an
additional interest in Inviso for $500,000, raising our total minority equity
interest to $3.8 million. As part of this strategic relationship, we provided
proprietary manufacturing capabilities and liquid crystal expertise, and Inviso
provided patented and proprietary technologies and components for the joint
development of microdisplay products. In the second quarter of 2001, we wrote
off our investment of $3.8 million in Inviso because we determined that our
investment was impaired, as that term is defined under generally accepted
accounting principles. Subsequent to our write-off, Inviso was unable to raise
funds to operate its business and has since ceased operations. In the second
quarter of 2002, we purchased all of the intellectual property of Inviso for
$780,000.

In August 2000, our wholly owned subsidiary, Three-Five Systems (Beijing)
Co., Ltd., entered into a strategic agreement with Heibei Jiya Electronics,
Co., Ltd. (Jiya), a Chinese-based manufacturer of LCD glass. Under the terms
of the agreement, Jiya agreed to provide LCD glass to us and reserve a
significant amount of LCD glass manufacturing capacity for us. In exchange, we
agreed to assist Jiya in further developing its LCD glass manufacturing
processes. At the end of the agreement term in February 2002, we had the
option to extend the agreement or to acquire a majority interest in Jiya. We
elected not to extend the agreement or acquire a majority interest.

In 2001, we invested $1.25 million in Silicon Bandwidth, Inc., a privately
held company providing unique semiconductor and optoelectronic interconnect
solutions based upon multiple, patented, proprietary technologies. We are
working closely with Silicon Bandwidth to design unique, cost-effective,
reconfigurable packaging platforms for LCoSmicrodisplays.

During the second quarter of 2001, we formed a new company, Three-D OLED
L.L.C., with Dupont Displays, a business unit of Dupont Corporation. We owned
51% of this new venture, and Dupont Displays owned 49%. The companies pledged
$3.0 million to the venture. Our share of that obligation was slightly over
$1.5 million. This venture was formed to design, assemble, and market OLED
(organic light emitting diode) display modules to OEMs worldwide with the focus
on glass substrate, passive matrix OLED displays. In the second quarter of
2002, we agreed with Dupont Displays to liquidate our joint venture with
Three-D OLED L.L.C. and enter into a non-equity based Strategic Manufacturing
and Supply Agreement. Under that agreement, the parties can continue to work
together in a fashion similar to the venture, but the relationship will be
nonexclusive. We have not worked with Dupont since the liquidation.

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In January 2002, we purchased the intellectual property of Zight
Corporation, a private company focused on microdisplays for personal display
system applications. In addition, we purchased certain key assets of Zight at
a creditors auction, and we hired seven key technical persons formerly
employed by Zight. The total purchase price was approximately $2.6 million, of
which approximately $2.0 million was related to intangibles.

In July 2002, we invested $5.0 million in ColorLink, Inc. ColorLink has a
leading position worldwide in the development and manufacture of color
management technologies for LCoSmicrodisplays. ColorLinks products consist
of color management components and system architectures that are critical for
digital projection systems that use high-resolution microdisplays. Those
projection systems include color monitors, high-definition televisions and
multi-media projectors. This investment furthers our efforts to accelerate as
much as possible the establishment of the necessary infrastructure for LCoS
microdisplays. An additional $81,000 was recorded as investment in ColorLink
during the third quarter of 2002 for legal and due diligence expenses.

In September 2002, we purchased the assets and ongoing business of AVT, a
privately held company that specializes in the design and integration of
complex, high-resolution display systems. AVT designs and provides customized
and ruggedized flat panel, touchscreen, and rackmount systems for original
equipment manufacturers including General Electric, Westinghouse, Gillette and
the U.S. military. AVT sources its display components from a variety of
companies including Sony, Sharp, NEC, LG, and Samsung. The purchase price of
the acquisition was $12.0 million, which we paid entirely in cash. The
purchase agreement also calls for a residual purchase payment of $2.0 million
should the AVT division achieve certain revenue and profit objectives for 2002
and 2003.

In December 2002, we purchased the stock of ETMA Corporation, a privately
held company that is an electronic manufacturer for OEM customers in the
automotive, computer/server, medical monitoring, and Internet security
industries. ETMA offers the manufacturing capabilities of six surface mount
manufacturing lines, including one dedicated to new product introduction and
prototyping activity. ETMA provides engineering support, automated printed
circuit board assembly, in-circuit and functional testing, systems integration
and box build, complete supply chain management, and turnkey packaging and
fulfillment services. The purchase price of the acquisition was $38.1 million,
which we paid entirely in cash.

In January 2003, we signed licensing and manufacturing agreements with
Data International Co., Ltd. of Taiwan. Under those agreements, we become the
exclusive channel in the Americas for standard and custom LCD products
manufactured by Data International. We also have the right to sell those
products through its worldwide channels. The agreements provide us with access
to a full suite of standard display products that will round out our existing
standard product portfolio. In conjunction with the agreement, we have
established a sales office in Orlando and hired sales and applications
engineering personnel who have supported Data Internationals products
throughout North and South America for the past ten years. The cost of the
license is anticipated to be $4.0 million, of which $1.0 million was paid upon
signing and the $3.0 million will be due over the next two years. The unpaid
$3.0 million is subject to reduction if certain revenue and margin targets are
not met.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of
operations are based upon our financial statements, which have been prepared in
accordance with generally accepted accounting principles (GAAP) in the United
States. During preparation of these financial statements, we are required to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates and judgments,
including those related to sales returns, pricing concessions, bad debts,
inventories, investments, fixed assets, intangible assets, income taxes,
pensions and contingencies. We base our estimates on historical experience and
on various other assumptions that we believe are reasonable under the
circumstances. The results form the basis for making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our financial
statements.

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We recognize sales when persuasive evidence of a sale exists; that is, a
product is shipped under an agreement with a customer, risk of loss and title
have passed to the customer, the fee is fixed or determinable, and collection
of the resulting receivable is reasonably assured. Sales allowances are
estimated based upon historical experience of sales returns or pricing
concessions. We recognize revenue related to engineering and tooling services
after service has been rendered, which is determined based upon completion
of agreed upon milestones or deliverables.

We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. We
determine the adequacy of this allowance by regularly evaluating individual
customer receivables and considering a customers financial condition, credit
history, and current economic conditions. If the financial condition of our
customers were to deteriorate, additional allowances may be required.

We write down our inventory for estimated obsolescence or unmarketable
inventory. We write down our inventory to estimated market value based upon
assumptions about future demand and market conditions. If actual market
conditions are less favorable than those projected by us, additional inventory
write-downs may be required.

Pursuant to Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes,
income taxes are recorded based on current year amounts payable or refundable,
as well as the consequences of events that give rise to deferred tax assets and
liabilities. We base our estimate of current and deferred taxes on the tax
laws and rates that are currently in effect in the appropriate jurisdiction.
Changes in tax laws or rates may affect the current amounts payable or
refundable as well as the amount of deferred tax assets or liabilities.

We currently have $13.2 million of net deferred tax assets resulting
primarily from net operating loss and tax credit carryforwards. SFAS No. 109
requires that a valuation allowance be established when it is more likely than
not that all or a portion of a deferred tax asset will not be realized.
Changes in valuation allowances from period to period are included in our tax
provision in the period of change. In determining whether a valuation
allowance is required, we take into account all evidence with regard to the
utilization of a deferred tax asset including our past earnings history,
expected future earnings, the character and jurisdiction of such earnings,
unsettled circumstances that, if unfavorably resolved, would adversely affect
utilization of a deferred tax asset, carryback and carryforward periods, and
tax strategies that could potentially enhance the likelihood of realization of
a deferred tax asset. We believe that the net deferred tax assets of $13.2
million will be realized based primarily on our projected future earnings and
scheduling of our deferred tax liabilities. However, the amount of the
deferred tax assets actually realized could differ if we have little or no
future earnings.

At December 31, 2002, we have a valuation allowance of $2.1 million for
deferred tax assets related to a capital loss carryforward and certain foreign
tax credit.

A deferred U.S. tax liability has not been provided on the undistributed
earnings of certain foreign subsidiaries because it is our intent to
permanently reinvest such earnings. Undistributed earnings of foreign
subsidiaries, which have been, or are intended to be, permanently invested in
accordance with APB No. 23, Accounting for Income Taxes  Special Areas,
aggregated approximately $7.2 million at December 31, 2002.

Long-term assets, such as Long-term Investments, Property, Plant and
Equipment, Intangibles, Goodwill and Other Investments, are originally recorded
at cost. On an on-going basis, we assess these assets to determine if their
current recorded value is impaired. When assessing these assets, we examine
future cash flows to determine if impairment is applicable. These cash flows
are evaluated for objectivity by using weighted probability techniques and also
comparisons of past performance against projections. Assets may also be
evaluated by identifying independent market values. If we were to believe that
an assets value was impaired, we would write down the carrying value of the
identified asset and charge the impairment as an expense in the period in which
the determination was made.

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Results of Operations

The following table sets forth, for the periods indicated, the percentage
of net sales of certain items in our Consolidated Financial Statements.

|                                                     |                                       |  |                          |      |      |  |       |       |  |  |       |      | 
|---------------------------------------------------- | ------------------------------------- |  | ------------------------ | ---- | ---- |  | ----- | ----- |  |  | ----- | ---- | 
|                                                     |                                       |  | Years Ended December 31,
|                                                     |                                       |  |                         
|                                                     |                                       |  | 2000                     |      | 2001 |  | 2002 
|                                                     |                                       |  |                          |      |      |  |      
|Net sales                                            |                                       |  | 100.0                    | %    |      |  | 100.0 | %     |  |  | 100.0 | %   
|                                                     |                                       |  |                          |      |      |  |       |       |  |  |       |     
|Costs and expenses:                                  |                                       |  |                          |      |      |  |       |       |  |  |       |     
|                                                     | Cost of sales                         |  |                          | 77.6 |      |  |       | 102.0 |  |  |       | 96.7 | 
|                                                     | Selling, general, and administrative  |  |                          | 5.9  |      |  |       | 8.5   |  |  |       | 12.9 | 
|                                                     | Research, development and engineering |  |                          | 8.3  |      |  |       | 14.8  |  |  |       | 20.4 | 
|                                                     | Write-down of assets held for sale    |  |                          |     |      |  |       |      |  |  |       | 5.2  | 
|                                                     | Amortization of customer lists        |  |                          |     |      |  |       |      |  |  |       | 0.3  | 
|                                                     |                                       |  |                          |      |      |  |       |       |  |  |       |     
|                                                     |                                       |  | 91.8                     |      |      |  | 125.3 |       |  |  | 135.5 |     
|                                                     |                                       |  |                          |      |      |  |       |       |  |  |       |     
|Operating income (loss)                              |                                       |  | 8.2                      |      |      |  | (25.3 | )     |  |  | (35.5 | )   
|Other income, net                                    |                                       |  | 4.5                      |      |      |  | 2.9   |       |  |  | 4.0   |     
|Minority interest in loss of
consolidated subsidiary |                                       |  |                         |      |      |  | 0.1   |       |  |  | 0.1   |     
|                                                     |                                       |  |                          |      |      |  |       |       |  |  |       |     
|Income (loss) before income taxes                    |                                       |  | 12.7                     |      |      |  | (22.3 | )     |  |  | (31.4 | )   
|                                                     |                                       |  |                          |      |      |  |       |       |  |  |       |     
|Provision for (benefit from) income taxes            |                                       |  | 3.5                      |      |      |  | (7.4  | )     |  |  | (12.1 | )   
|                                                     |                                       |  |                          |      |      |  |       |       |  |  |       |     
|Net income (loss)                                    |                                       |  | 9.2                      | %    |      |  | (14.9 | )%    |  |  | (19.3 | )%  
|                                                     |                                       |  |                          |      |      |  |       |       |  |  |       |     

Year ended December 31, 2002 compared to year ended December 31, 2001

Net Sales.Net sales decreased 26.1% to $88.0 million in 2002 from $119.1
million in 2001. The reduction was primarily because of our reduced volume of
business with our major customer Motorola. We shipped 9.5 million units to
Motorola in 2002 compared to 11.7 million units in 2001. In addition, the
average selling price of those Motorola units shipped in 2002 was substantially
lower than in 2001 because of pricing pressures in the high-volume, monochrome
LCD market. Shipments were lower to Motorola because of our strategic decision
not to seek business from customers that would produce very low or negative
gross margins.

Cost of Sales.Cost of sales decreased to 96.7% of net sales in 2002 from
102.0% in 2001. This percentage decrease resulted primarily from
cost-reduction efforts undertaken throughout 2002. The cost of sales in the ISD
division continued to be higher than our long-range expectations because our
fixed costs were under absorbed at our overseas factories as a result of excess
capacity. Also contributing to the high cost of sales was the sale of LCoS
microdisplay products at a gross margin loss. We incurred a loss for our LCoS
microdisplay sales primarily because of the low volume of shipments and low
manufacturing yields in those start-up products.

Selling, General, and Administrative Expense.Selling, general, and
administrative expense increased 11.9% to $11.3 million in 2002 from $10.1
million in 2001. In 2002, SG&A consisted primarily of fixed costs because we
had no distribution costs and just a small sales force that focused on custom
products. Thus, SG&A increased in 2002, primarily as a result of our
acquisitions of AVT and ETMA.

Research, Development, and Engineering Expense.Research, development,
and engineering expense increased slightly to $18.0 million in 2002 from $17.6
million in 2001. More than 80% of our research, development, and engineering
expense related to our Microdisplay division as we continued intensive efforts
on continued development of LCoSmicrodisplays.

Write-Down of Assets Held for Sale.During the second quarter of 2002, we
signed a Cooperative Agreement with a Chinese company under which we agreed to
sell the equipment of our front-end manufacturing LCD line and establish a
supply agreement. Under the terms of the Cooperative Agreement, and in
exchange for our LCD equipment, we will receive $3.0 million in cash, favorable
LCD glass pricing, and flexible yet assured manufacturing capacity from this
strategic partner. Thus far, we have received $2.1 million. As a result of
signing the Cooperative Agreement, we realized a charge of $4.5 million for the
write-down on the LCD equipment to be sold to the Chinese company. This charge
was reported as a separate line item in operating expense.

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Amortization of Customer Lists.As a result of the acquisitions of AVT and
ETMA, we have added a new line item for operating costs related to the
amortization of intangible assets of customer lists that have definable lives.
We had no such expense in 2001 and $256,000 for 2002. Most of that expense
related to the acquisition of AVT. The initial total amount of amortizable
assets associated with AVT was $3.0 million. We also acquired ETMA Corporation
in the fourth quarter of 2002, and the initial total amount of amortizable
assets associated with ETMA was $2.0 million. The AVT-related assets will be
amortized over five years while the ETMA assets will be amortized over three
years.

Other Income (Expense), Net.Other income in 2002 was $3.5 million,
slightly higher than other income of $3.4 million in 2001. Net interest income
in 2002 was $3.3 million compared to $7.3 million in 2001. We incurred a $3.8
million write-off of our investment in Inviso, Inc. in 2001 that offset the
much higher interest income so that Other Income was almost identical for 2002
and 2001.

Benefit from Income Taxes.We recorded a benefit from income taxes of
$10.7 million in 2002 compared to a benefit for income taxes of $8.7 million in
2001. In recording the benefit, we used an effective tax rate of 38.6% in 2002
compared to an effective tax rate of 33.0% in 2001. The difference was
primarily a change in relative operational results between U.S. and foreign
jurisdictions. In other words, a greater portion of our net loss in 2002
related to higher tax rate jurisdictions, thereby causing the accrued tax
benefit to be a greater percentage of our net loss. The benefit for income
taxes that we have recorded has generated a $13.2 million cumulative deferred
tax asset at December 31, 2002, primarily related to net operating loss and tax
credit carryforwards. We have taken some valuation allowances with respect to
certain capital loss and foreign tax credit carryforwards, but have taken no
valuation allowances with respect to other deferred tax assets because we
believe it is more likely than not that the deferred tax assets on the books
will be fully realized.

Net Loss.In 2002, we recorded a net loss of $17.0 million, or $0.79 per
diluted share, compared to a net loss of $17.8 million, or $0.83 per diluted
share, in 2001. The ISD segment recorded a net loss of $3.9 million, or $0.18
per share, in 2002 compared to a net loss of $3.7 million, or $0.17 per share,
in 2001. The increased loss was the result of allocating 50%, or $1.7 million,
of the net other income to the Microdisplay segment compared to 0% allocated in
2001. Offsetting this loss of income was a cost-reduction effort that improved
our gross margins. The loss on the sale of our LCD line offset some, but not
all, of these cost reductions. The Microdisplay segment recorded a net loss of
$13.1 million, or $0.61 per diluted share, in 2002 compared to a net loss of
$14.1 million, or $0.66 per diluted share, in 2001. The decreased loss was the
result of allocating 50%, or $1.7 million, of the net other income to the
Microdisplay segment compared to 0% allocated in 2001.

Year ended December 31, 2001 compared to year ended December 31, 2000

Net Sales.Net sales decreased 25.9% to $119.1 million in 2001 from
$160.7 million in 2000. Although some of the decrease was attributable to the
reduced volume of unit shipments, the revenue decrease was primarily the result
of decreased selling prices of LCD modules due to excess worldwide LCD
capacity. We shipped 13.0 million units in 2001 versus 14.9 million units in
2000.

Cost of Sales.Cost of sales increased to 102.0% of net sales in 2001
from 77.6% in 2000. This percentage increase resulted primarily from reduced
selling prices and reduced operating efficiencies. Also contributing to the
increased cost of sales was the sale of LCoSmicrodisplay products at a loss.
We incurred a loss at the gross margin line for our LCoSmicrodisplay sales
primarily because of very low manufacturing yields.

Selling, General, and Administrative Expense.Selling, general, and
administrative expense increased 6.3% to $10.1 million in 2001 from $9.5
million in 2000. Selling, general, and administrative expense was 8.5% of net
sales in 2001 compared to 5.9% of net sales in 2000. This percentage increase
was due to lower net sales in 2001.

Research, Development, and Engineering Expense.Research, development,
and engineering expense increased 32.3% to $17.6 million in 2001 from $13.3
million in 2000. Research, development, and engineering expense were 14.8% of
net sales in 2001 compared to 8.3% of net sales in 2000. Research,
development, and engineering expense overall increased as the result of the
continued development of LCoSmicrodisplays.

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The selling, general, and administrative expense and the research,
development, and engineering expense in each year included significant
operating expenditures in LCoSmicrodisplays at a time when there was very
little LCoSmicrodisplay revenue. In 2001, we incurred approximately $13.5
million of operating expenses specifically related to LCoSmicrodisplays
compared to approximately $9.4 million in 2000.

Other Income (Expense), Net.Other income in 2001 was $3.4 million
compared to other income of $7.2 million in 2000. The primary difference was
the 2001 write-off of our $3.8 million investment in Inviso, Inc. Net interest
earned in 2001 was $7.3 million compared to $7.4 million in 2000.

Provision for (Benefit from) Income Taxes.We recorded a benefit from
income taxes of $8.7 million in 2001 compared to a provision for income taxes
of $5.5 million in 2000. In recording the benefit, we used an effective tax
rate of 33.0% in 2001 compared to an effective tax rate of 27.1% in 2000. The
difference was primarily a change in relative operational results between U.S.
and foreign jurisdictions and a higher percentage of research and development
credits recorded during 2000.

Net Income (Loss).In 2001, we recorded a net loss of $17.8 million, or
$0.83 per diluted share, compared to net income of $14.8 million, or $0.69 per
diluted share, in 2000. We recorded several unusual expense items in the
second quarter of 2001, including the $3.8 million write-off of our investment
in Inviso, Inc., the $2.4 million write-off of certain inventory, and the $1.3
million write-off of an Enterprise Resource Planning system implementation. On
an after-tax basis, those unusual expenses totaled $5.1 million, or $0.24 per
diluted share. The ISD segment recorded a net loss of $3.7 million, or $0.17
loss per diluted share, in 2001 compared to net income of $20.9 million, or
$0.97 earnings per share in 2000. The decline in revenue was related to
intense pricing pressures for our modules and the worldwide economic slowdown
in 2001. The microdisplay segment recorded a net loss of $14.1 million, or
$0.66 per diluted share, in 2001 compared to a net loss of $6.1 million, or
$0.28 per diluted share, in 2000. The increased loss was as a result of
intensified RD&E efforts to bring microdisplays to market.

Liquidity and Capital Resources

At December 31, 2002, we had cash, cash equivalents, and short- and
long-term liquid investments of $80.6 million compared to $156.1 million at
December 31, 2001.

In 2002, we had $10.2 million in net cash outflow from operations compared
to $4.1 million in net cash outflow from operations in 2001. Excluding
inventory and DSO (Days Sales Outstanding) data related to our ETMA
acquisition, our inventory turns were 6.4 and DSOs were 62 days for the year
2002 as compared with 6.7 inventory turns and 64 DSOs for the year 2001. Our
depreciation and amortization expense was $6.0 million in 2001 and $7.4 million
in 2002.

Our working capital was $107.9 million at December 31, 2002, down from
$169.1 million at December 31, 2001. The decrease in working capital was
primarily because of reduced cash balances as a result of operating cash
outflows and acquisitions. Our current ratio at December 31, 2002 was 7.3-to-1
compared to 8.8-to-1 at December 31, 2001.

In May 2002, we renegotiated our credit facility with Comerica Bank. That
credit facility is a $15.0 million unsecured revolving line of credit that
matures in July 2003. No borrowings were outstanding under that credit facility
on December 31, 2002. Advances under the facility may be made as prime rate
advances, which accrue interest payable monthly at the banks prime lending
rate, or as LIBOR rate advances, which bear interest at 150 basis points in
excess of the LIBOR base rate. In May 2002, our Beijing subsidiary renewed its
credit facility with the Bank of China. As of December 31, 2002, our Beijing
subsidiary had an outstanding $2.7 million term loan due April 30, 2003 to the
Bank of China, which was secured by a $3.0 million standby letter of credit
issued by Comerica Bank.

Acquisitions, investments, and purchases of intangibles, property, plant,
and equipment during 2002 were approximately $65.8 million, including $4.6
million in capital expenditures, mainly associated with microdisplays, $6.0
million in intangibles associated with microdisplays, $5.1 million invested in
ColorLink, and $50.1 million in acquisitions with ETMA and AVT. During 2002, we
purchased 260,600 shares of common stock for a total purchase price of $1.4
million, including 145,400 shares in the fourth quarter for $717,000.

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The following tables list our contractual obligations and commercial
commitments:

|                                   |  |               |        |             |  |           |       |           |  |                        |       |  |  |   |       |  |  |   |        | 
|---------------------------------- |  | ------------- | ------ | ----------- |  | --------- | ----- | --------- |  | ---------------------- | ----- |  |  | - | ----- |  |  | - | ------ | 
|                                   |  |               |        |             |  |           |       |           |  | Payments due by Period |       |  |  |  
|Contractual Obligations            |  | Total Amounts |        | Less        |  |           |       |           | 
|(in thousands)                     |  | Committed     |        | than 1 Year |  | 1-3 Years |       | 4-5 Years |  | 6 Years and Over      
|                                   |  |               |        |             |  |           |       |           |  |                       
|Term Loan                          |  | $             | 2,734  |             |  | $         | 2,714 |           |  | $                      | 15    |  |  | $ | 5     |  |  | $ |       | 
|Operating Leases                   |  |               | 22,959 |             |  |           | 3,646 |           |  |                        | 5,641 |  |  |   | 3,534 |  |  |   | 10,138 | 
|                                   |  |               |        |             |  |           |       |           |  |                        |       |  |  |   |       |  |  |   |        | 
|Total Contractual Cash Obligations |  | $             | 25,693 |             |  | $         | 6,360 |           |  | $                      | 5,656 |  |  | $ | 3,539 |  |  | $ | 10,138 | 
|                                   |  |               |        |             |  |           |       |           |  |                        |       |  |  |   |       |  |  |   |        | 

|                             |  |               |     |             |  |           |    |           |  |                                            |     |  |  |   |     |  |  |  |   | 
|---------------------------- |  | ------------- | --- | ----------- |  | --------- | -- | --------- |  | ------------------------------------------ | --- |  |  | - | --- |  |  |  | - | 
|                             |  |               |     |             |  |           |    |           |  | Amount of Commitment Expiration Per Period
|Other Commercial Commitments |  | Total Amounts |     | Less        | 
|(in thousands)               |  | Committed     |     | than 1 Year |  | 1-3 Years |    | 4-5 Years |  | 6 Years and Over                          
|                             |  |               |     |             |  |           |    |           |  |                                           
|Guarantee                    |  | $             | 428 |             |  | $         | 92 |           |  | $                                          | 203 |  |  | $ | 133 |  |  |  |  | 

The term loan includes a $2.7 million loan from the Bank of China and it
includes an interest-free vehicle financing of $28,000.

The operating leases include a lease for our factory in Manila and our
ground lease in Tempe, Arizona. These leases are described in detail in Note 8
of the Notes to our Consolidated Financial Statements for 2002 included
elsewhere in this Form 10-K. The guarantee relates to our guarantee in
connection with a Small Business Administration loan to VoiceViewer Technology,
Inc., a private company developing microdisplay products. The $3.0 million
standby letter of credit issued by Comerica has not been included in the Other
Commercial Commitments table because it only exists to secure the term loan
obligation of $2.7 million, which is already included in the table for
Contractual Obligations.

In September 2002, we purchased the assets and ongoing business of AVT.
The purchase agreement calls for a residual purchase payment of $2.0 million
should the AVT division achieve certain revenue and profit objectives for 2002
and 2003.

In January 2003, we signed licensing and manufacturing agreements with
Data International Co., Ltd. of Taiwan. The cost of the license is anticipated
to be $4.0 million of which $1.0 million was paid upon signing and the other
$3.0 million is due over the next two years. The unpaid $3.0 million is
subject to reduction if certain revenue and margin targets are not met.

We have no other long-term debt, capital lease obligations, unconditional
purchase obligations, or other long-term obligations, and we do not have any
other commercial commitments or other off-balance sheet arrangements.

We believe that our existing balances of cash, cash equivalents, and
investments will provide adequate sources to fund our operations and planned
expenditures through 2003 and 2004, as well as to meet our contractual
obligations. Specifically, we have over $80 million in cash, cash
equivalents, and short- term investments. Our capital expenditures for 2003 are
expected to be less than $10.0 million, and we expect operating cash outflow to
consume only a small portion of our cash reserves. We continue to seek other
alliances or acquisitions and additional relationships with regard to the
strategic development of both business segments. New acquisitions or alliances
may result in our needing to expand our loan commitments or pursue alternate
methods of financing or raise capital. We cannot provide assurance that
adequate additional loan commitments or alternative methods of financing will
be available or, if available, that they will be on terms acceptable to us.

Impact of Recently Issued Standards.

In September 2001, the FASB issued SFAS No. 141, Business Combinations,
and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141
requires companies to apply the purchase method of

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accounting for all business combinations initiated after June 30, 2001 and
prohibits the use of the pooling-of-interest method. SFAS No. 142 requires
identifiable intangible assets to be recognized separately from goodwill. In
addition, it eliminates the amortization of all existing and newly acquired
goodwill on a prospective basis and requires companies to assess goodwill for
impairment, at least annually, based on the fair value of the reporting unit.
We adopted SFAS Nos. 141 and 142 on January 1, 2002, and there was no material
impact on our financial position or results of operations.

In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and the accounting and reporting provisions of APB
Opinion No. 30, Reporting the Results of Operations  Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions. SFAS No. 144 modifies the
method in which companies account for certain asset impairment losses. We
adopted SFAS No. 144 on January 1, 2002 and there was no material impact on our
financial position or results of operations.

In July 2001, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 replaces EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring), and will apply to exit or disposal
activities initiated after December 31, 2002. We have reviewed the requirements
of SFAS No. 146 and believe the adoption of this statement will not have a
material impact on our financial statements.

In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation -Transition and Disclosure. This Statement amends
SFAS No. 123 to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. Specifically, SFAS No. 148 prohibits companies from utilizing
the prospective method of transition, the only method offered under the
original SFAS No. 123, in fiscal years beginning after December 15, 2003.
However, the statement permits two additional transition methods for companies
that adopt the fair value method of accounting for stock-based compensation,
which include the modified prospective and retroactive restatement methods.
Under the prospective method, expense is recognized for all employee awards
granted, modified, or settled after the beginning of the fiscal year in which
the recognition provisions are first applied. The modified prospective method
recognizes stock-based employee compensation cost from the beginning of the
fiscal year in which the provisions are first applied, as if the fair value
method had been used to account for all employee awards granted, modified, or
settled in fiscal years beginning after December 15, 1994. Under the
retroactive restatement method, all periods presented are restated to reflect
stock-based employee compensation cost under the fair value method for all
employee awards granted, modified, or settled in fiscal years beginning after
December 15, 1994. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results
using a prescribed tabular format and requiring disclosure in the Summary of
Significant Accounting Policies or its equivalent. We have adopted the new
disclosure requirements for 2002, and are currently evaluating the impact if we
were to adopt the fair value method of accounting for stock-based employee
compensation under all three methods.

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This Interpretation addresses
the disclosures to be made by a guarantor in its financial statements and its
obligations under guarantees. The Interpretation also clarifies the
requirements related to the recognition of a liability by the guarantor at the
inception of a guarantee. Per the interpretation, initial recognition of a
liability shall be applied only on a prospective basis to guarantees issued or
modified after December 31, 2002. We have reviewed the requirements of FIN 45
and believe the adoption of this interpretation will not have a material impact
on our financial statements.

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Rule 10b5-1 Trading Plans

Our Insider Trading Policy permits our directors, officers, and other key
personnel to establish purchase and sale programs in accordance with Rule
10b5-1 adopted by the Securities and Exchange Commission. The rule permits
employees to adopt written plans at a time before becoming aware of material
nonpublic information and to sell shares according to a plan on a regular basis
(for example, weekly or monthly), regardless of any subsequent nonpublic
information they receive. In our view, Rule 10b5-1 plans are beneficial
because systematic, pre-planned sales that take place over an extended period
should have a less disruptive influence on the price of our stock. We also
believe plans of this type are beneficial because they inform the marketplace
about the nature of the trading activities of our directors and officers. In
the absence of such information, the market could mistakenly attribute
transactions as reflecting a lack of confidence in our company or an indication
of an impending event involving our company. We recognize that our directors
and officers may have reasons totally apart from the company in determining to
effect transactions in our common stock. These reasons could include the
purchase of a home, tax and estate planning, the payment of college tuition,
the establishment of a trust, the balancing of assets, or other personal
reasons. The establishment of any trading plan involving our company requires
the pre-clearance by our Chief Executive Officer or Chief Financial Officer.
An individual adopting a trading plan must comply with all requirements of Rule
10b5-1, including the requirement that the individual not possess any material
nonpublic information regarding our company at the time of the establishment of
the plan. In addition, sales under a trading plan may be made no earlier than
30 days after the plan establishment date.

No officers currently maintain trading plans.




ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Derivative Financial Instruments, Other Financial Instruments, and
Derivative Commodity Instruments

At December 31, 2002, we did not participate in any derivative financial
instruments, or other financial and commodity instruments for which fair value
disclosure would be required under Statement of Financial Accounting Standards
No. 107. We hold no investment securities that would require disclosure of
market risk.

We have certain receivables denominated in Chinese renminbi. To eliminate
our exposure to changes in the U.S. dollar/Chinese renminbi exchange rate, we
have entered into forward contracts to protect future cash flows. We have
designated the forward contracts as cash flow hedges. Accordingly, we account
for changes in the fair value of our forward contracts, based on changes in the
forward exchange rate, with all changes in fair value reported in other
comprehensive income. Amounts in other comprehensive income will be
reclassified into earnings upon settlement of the forward contract. As of
December 31, 2002, we had no forward contracts outstanding.

Primary Market Risk Exposures

Our primary market risk exposures are in the areas of interest rate risk
and foreign currency exchange rate risk. We have a revolving line of credit
with a variable interest rate of LIBOR (1.48% at December 31, 2002) plus 150
basis points. At December 31, 2002, no borrowings were outstanding under this
line of credit.

We generally sell our products and services and negotiate purchase orders
with our foreign suppliers in U.S. dollars. However, we have certain foreign
currency exchange exposure as a result of our manufacturing operations in the
Philippines and China and our sales and distribution facility in the United
Kingdom. We have not incurred any material exchange gains or losses to date.
Some of the expenses of these foreign operations are denominated in the
Philippine peso, Chinese renminbi, and British pound sterling, respectively.
These expenses include local salaries and wages, utilities, and some operating
supplies. As a result of these sales and expenses, we do have accounts
receivable and cash deposits in local currencies. We believe, however, that
the operating expenses currently incurred in foreign currencies other than the
Chinese renminbi are immaterial, and therefore any associated market risk is
unlikely to have a material adverse effect on our business, results of
operations, or financial condition. Although the Chinese currency currently is
stable, its value in relation to the U.S. dollar is determined by the Chinese
government. There is general speculation that China may devalue its currency.
Devaluation of the Chinese currency could result in translation adjustments to
our balance sheet as well as reportable losses depending on our monetary
balances and outstanding indebtedness at the time of devaluation. The
government of China historically has made it difficult to convert its local
currency into foreign currencies. Although we from time to time may enter

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into hedging transactions in order to minimize our exposure to currency rate
fluctuations, the Chinese currency is not freely traded and thus is difficult
to hedge. In addition, the government of China has imposed restrictions on
Chinese currency loans to foreign-operated entities in China. Based on the
foregoing, we cannot provide assurance that fluctuations and currency exchange
rates in the future will not have an adverse effect on our operations.




ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to the financial statements, the reports thereon, the
notes thereto, and the supplementary data commencing at page F-1 of this
report, which financial statements, reports, notes, and data are incorporated
herein by reference.




ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.




PART III




ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item relating to our directors is
incorporated herein by reference to the definitive Proxy Statement to be filed
pursuant to Regulation 14A of the Exchange Act for our 2003 Annual Meeting of
Stockholders. The information required by this Item relating to our executive
officers is included in Item 1, Business  Executive Officers of this report.




ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2003 Annual Meeting of Stockholders.




|         |  |                                                                                               
|-------- |  | ----------------------------------------------------------------------------------------------
|
|ITEM 12. |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The information required by this Item is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2003 Annual Meeting of Stockholders.




ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the
Exchange Act for our 2003 Annual Meeting of Stockholders.




ITEM 14. CONTROLS AND PROCEDURES

As of a date within 90 days prior to the date of filing of this report,
our Chief Executive Officer and Chief Financial Officer have reviewed and
evaluated the effectiveness of our disclosure controls and procedures, which
included inquiries made to certain other of our employees. Based on their
evaluation, our Chief Executive Officer and Chief Financial Officer have each
concluded that our disclosure controls and procedures are effective and
sufficient to ensure that we record, process, summarize, and report information
required to be disclosed by us in our periodic reports filed under the
Securities Exchange Act within the time periods specified by the Securities and
Exchange Commissions rules and forms. Subsequent to the date of their
evaluation, there have not been any significant changes in our internal
controls or in other factors that could significantly affect these controls,
including any corrective action with regard to significant deficiencies and
material weaknesses.

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PART IV




ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)  Financial Statements and Financial Statement Schedule



| | (1) |  | Financial Statements are listed in the Index to Financial
Statements on page F-1 of this report.
| | --- |  | ------------------------------------------------------------------------------------------------
|
| | (2) |  | Financial Statement Schedule:                                                                   

Schedule II Valuation and Qualifying Accounts and Reserves is set forth on
page S-1 of this report.

Other schedules are omitted because they are not applicable, not required,
or because the required information is included in the consolidated financial
statements or notes thereto.

(b)  Reports on Form 8-K

None.

(c)  Exhibits

|               |  |                                                                                                                                                                                                                     
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Exhibits                                                                                                                                                                                                            
|               |  |                                                                                                                                                                                                                     
|2              |  | Amended and Restated Agreement and Plan of Reorganization(1)                                                                                                                                                        
|               |  |                                                                                                                                                                                                                     
|3(i)(a)        |  | Amended and Restated Certificate of Incorporation of the Company(2)                                                                                                                                                 
|               |  |                                                                                                                                                                                                                     
|3(i)(b)        |  | Certificate of Amendment of Restated Certificate of Incorporation(3)                                                                                                                                                
|               |  |                                                                                                                                                                                                                     
|3(i)(c)        |  | Certificate of Designation of Series A Junior Participating Preferred Stock(4)                                                                                                                                      
|               |  |                                                                                                                                                                                                                     
|3(ii)          |  | Amended and Restated Bylaws of the Company(5)                                                                                                                                                                       
|               |  |                                                                                                                                                                                                                     
|4.1            |  | Form of Certificate of Common Stock*                                                                                                                                                                                
|               |  |                                                                                                                                                                                                                     
|4.2            |  | Rights Agreement, dated as of April 26, 2001, between Three-Five Systems, Inc. and
Bank of New York, as Rights Agent(6)                                                                                             
|               |  |                                                                                                                                                                                                                     
|10.1           |  | Line of Credit Agreement between Three-Five Systems Limited and Barclays Bank,
PLC(7)                                                                                                                               
|               |  |                                                                                                                                                                                                                     
|10.2           |  | Ground Sublease dated April 1, 1994, between Papago Park Center, Inc. and
Three-Five Systems, Inc.(8)                                                                                                               
|               |  |                                                                                                                                                                                                                     
|10.3           |  | Amended and Restated 1990 Incentive Stock Option Plan (as Amended and Restated
through March 7, 2003)*                                                                                                              
|               |  |                                                                                                                                                                                                                     
|10.4           |  | Amended and Restated 1993 Stock Option Plan (as Amended and Restated through March
7, 2003)*                                                                                                                        
|               |  |                                                                                                                                                                                                                     
|10.5           |  | Amended and Restated 1994 Stock Option Plan for Non-Employee Directors (as Amended
and Restated through February 12, 2001)(9)                                                                                       
|               |  |                                                                                                                                                                                                                     
|10.6           |  | Amended and Restated 1997 Employee Stock Option Plan (as Amended and Restated
through November 27, 2002)*                                                                                                           
|               |  |                                                                                                                                                                                                                     
|10.7           |  | Form of Notice and Acceptance of Stock Option Grant for Amended and Restated 1997
Employee Stock Option Plan(10)                                                                                                    
|               |  |                                                                                                                                                                                                                     
|10.8           |  | Amended and Restated 1998 Stock Option Plan* (as Amended and Restated through
February 8, 2002)                                                                                                                     
|               |  |                                                                                                                                                                                                                     
|10.9           |  | Amended and Restated Directors Stock Plan (amended as of January 27, 2000)(11)                                                                                                                                     
|               |  |                                                                                                                                                                                                                     
|10.10          |  | 401(k) Profit Sharing Plan(12)                                                                                                                                                                                      
|               |  |                                                                                                                                                                                                                     
|10.11          |  | Credit Agreement dated January 21, 2000, by and among Three-Five Systems, Inc., its
subsidiaries, the Banks named therein, and Imperial Bank Arizona, as Agent and as
Issuing Bank(13)                              
|               |  |                                                                                                                                                                                                                     
|10.12          |  | Modification Agreement dated February 1, 2001, by and among Three-Five Systems,
Inc., its subsidiaries, the Banks named in the Credit Agreement, and Imperial Bank
as Agent and as Issuing Bank(14)                 
|               |  |                                                                                                                                                                                                                     
|10.13          |  | Second Modification Agreement dated September 30, 2001, by and among Three-Five
Systems, Inc., its subsidiaries, the Banks named in the Credit Agreement, and
Comerica Bank-California as Agent and as Issuing Bank*
|               |  |                                                                                                                                                                                                                     
|10.14          |  | Third Modification Agreement dated January 31, 2002, by and among Three-Five
Systems,                                                                                                                               

52



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##### Table of Contents



|               |  |                                                                                                                                                                          
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Exhibits                                                                                                                                                                 
|               |  |                                                                                                                                                                          
|               |  | Inc., its subsidiaries, the Banks named in the Credit Agreement, and
Comerica Bank-California as Agent and as Issuing Bank(15)                                           
|               |  |                                                                                                                                                                          
|10.15          |  | Technology License Agreement between Data International, Ltd. and TFS-DI dated
January 13, 2003*                                                                         
|               |  |                                                                                                                                                                          
|10.16          |  | Supply Agreement between Data International, Ltd. and TFS-DI dated January 13, 2003*                                                                                     
|               |  |                                                                                                                                                                          
|10.17          |  | Term Promissory Note dated January 13, 2003 executed by TFS-DI in favor of Data
International, Ltd.*                                                                     
|               |  |                                                                                                                                                                          
|21             |  | List of Subsidiaries*                                                                                                                                                    
|               |  |                                                                                                                                                                          
|23.1           |  | Consent of Deloitte & Touche LLP*                                                                                                                                        
|               |  |                                                                                                                                                                          
|23.2           |  | Notice Regarding Consent of Arthur Andersen LLP*                                                                                                                         
|               |  |                                                                                                                                                                          
|99.1           |  | Certification of the Chief Executive Officer of the Registrant, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002*
|               |  |                                                                                                                                                                          
|99.2           |  | Certification of the Chief Financial Officer of the Registrant, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002*



---

|* |  | Filed herein.
|- |  | -------------



|(1)  |  | Incorporated by reference to Exhibit 2 to the Registration Statement on
Form S-4 of TF Consolidation, Inc. (Registration No. 33-33944) as filed on
March 27, 1990.                               
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(2)  |  | Incorporated by reference to Exhibit 3(a) to the Registrants Form 10-QSB
for the quarter ended March 31, 1994, as filed on or about May 12, 1994.                                               
|    
|(3)  |  | Incorporated by reference to Exhibit 3(b) to the Registration Statement
on Form S-3 (Registration No. 333-35788) as filed on April 27, 2000, as
amended by Form S-3/A as filed on May 5, 2000.   
|    
|(4)  |  | Incorporated by reference to Exhibit 3(d) to the Registrants Form 8-A as
filed on May 10, 2001.                                                                                                 
|    
|(5)  |  | Incorporated by reference to Exhibit 3(b) to the Registration Statement
on Form S-3 (Registration No. 333-84083) as filed on July 30, 1999, as
amended by Form S-3/A as filed on August 26, 1999.
|    
|(6)  |  | Incorporated by reference to Exhibit 4(b) to the Registrants Form 8-A as
filed on May 10, 2001.                                                                                                 
|    
|(7)  |  | Incorporated by reference to Exhibit 10(c) to the Registration Statement
on Form S-4 of TF Consolidation, Inc. (Registration No. 33-33944) as filed
on March 27, 1990.                           
|    
|(8)  |  | Incorporated by reference to Exhibit 10(o) to the Registrants Form 10-K
for the fiscal year ended December 31, 1996, as filed on March 14, 1997.                                                
|    
|(9)  |  | Incorporated by reference to Exhibit 10(x) to the Registrants Form 10-Q
for the quarter ended June 30, 2001, as filed on July 27, 2001.                                                         
|    
|(10) |  | Incorporated by reference to Exhibit 10.5(b) to the Registration
Statement on Form S-8 (Registration No. 333-59234) as filed on April 19,
2001.                                                  
|    
|(11) |  | Incorporated by reference to Exhibit 10(y) to the Registration Station
Statement on Form S-8 (Registration No. 333-50689) as filed on November 3,
2000.                                          
|    
|(12) |  | Incorporated by reference to Exhibit 10(z) to the Registration Statement
on Form S-8 (Registration No. 333-57933) as filed on June 26, 1998.                                                     
|    
|(13) |  | Incorporated by reference to Exhibit 10(aa) to the Registrants Form 10-Q
for the quarter ended June 30, 2000, as filed on July 27, 2000.                                                        
|    
|(14) |  | Incorporated by reference to Exhibit 10(cc) to the Registrants Form 10-K
for the fiscal year ended December 31, 2000, as filed on March 13, 2001.                                               
|    
|(15) |  | Incorporated by reference to Exhibit 10(cc) to the Registrants Form 10-Q
for the quarter ended March 31, 2002, as filed on April 19, 2002.                                                      

53



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

|                     |  |                          |  |                                                      
|-------------------- |  | ------------------------ |  | -----------------------------------------------------
|                     |  | THREE-FIVE SYSTEMS, INC.
|                     |  |                          |  |                                                      
|Date: March 28, 2003 |  | By:                      |  | /s/ Jack L. Saltich                                  
|                     |  |                          |  |                                                      
|                     |  |                          |  | Jack L. Saltich
President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

|                                             |  |                                                                                                                                     |  |               
|-------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------- |  | --------------
|Name                                         |  | Title                                                                                                                               |  | Date          
|                                             |  |                                                                                                                                     |  |               
|/s/ Jack L. Saltich

Jack L. Saltich         |  | President, Chief Executive
Officer (Principal Executive
Officer), and Director                                                      |  | March 28, 2003
|                                             |  |                                                                                                                                     |  |               
|/s/ Jeffrey D. Buchanan

Jeffrey D. Buchanan |  | Executive Vice President, Chief
Financial Officer, Secretary,
Treasurer (Principal Financial
and Accounting` Officer), and
Director |  | March 28, 2003
|                                             |  |                                                                                                                                     |  |               
|/s/ David C. Malmberg

David C. Malmberg     |  | Chairman of the Board of Directors                                                                                                  |  | March 28, 2003
|                                             |  |                                                                                                                                     |  |               
|/s/ Kenneth M. Julien

Kenneth M. Julien     |  | Director                                                                                                                            |  | March 28, 2003
|                                             |  |                                                                                                                                     |  |               
|/s/ David P. Chavoustie

David P. Chavoustie |  | Director                                                                                                                            |  | March 28, 2003
|                                             |  |                                                                                                                                     |  |               
|/s/ Murray A. Goldman

Murray A. Goldman     |  | Director                                                                                                                            |  | March 28, 2003
|                                             |  |                                                                                                                                     |  |               
|/s/ Henry L. Hirvela

Henry L. Hirvela       |  | Director                                                                                                                            |  | March 28, 2003
|                                             |  |                                                                                                                                     |  |               
|/s/ Thomas H. Werner

Thomas H. Werner       |  | Director                                                                                                                            |  | March 28, 2003

54



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##### Table of Contents






CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Jack L. Saltich, certify that:



|1. |  | I have reviewed this annual report on Form 10-K of Three-Five Systems, Inc.;                                                                                                                                                                                                                                            
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations, and cash flows of
the registrant as of, and for, the periods presented in this annual
report;                  
|  
|4. |  | The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:                                                                                                   



| | a) |  | Designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this annual report is being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | Evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this annual report (the Evaluation
Date); and                                                                                                    
|
| | c) |  | Presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons performing
the equivalent functions):
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | All significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrants ability to record, process, summarize, and report
financial data and have identified for the registrants auditors
any material weaknesses in internal controls; and
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | Any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrants internal controls; and                                                                                                                                         



|6. |  | The registrants other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                     |  |                                                      
|-------------------- |  | -----------------------------------------------------
|Date: March 28, 2003 |  | /s/ Jack L. Saltich                                  
|                     |  |                                                      
|                     |  | Jack L. Saltich
President and Chief Executive Officer

55



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##### Table of Contents






CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Jeffrey D. Buchanan, certify that:



|1. |  | I have reviewed this annual report on Form 10-K of Three-Five Systems, Inc.;                                                                                                                                                                                                                                            
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations, and cash flows of
the registrant as of, and for, the periods presented in this annual
report;                  
|  
|4. |  | The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:                                                                                                   



| | a) |  | Designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this annual report is being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | Evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this annual report (the Evaluation
Date); and                                                                                                    
|
| | c) |  | Presented in this annual report our conclusions about
the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;                                                                                                                        
|



|5. |  | The registrants other certifying officer and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit
committee of the registrants board of directors (or persons performing
the equivalent functions):
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | All significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrants ability to record, process, summarize, and report
financial data and have identified for the registrants auditors
any material weaknesses in internal controls; and
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | Any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrants internal controls; and                                                                                                                                         





|6. |  | The registrants other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                     |  |                                                                      
|-------------------- |  | ---------------------------------------------------------------------
|Date: March 28, 2003 |  | /s/ Jeffrey D. Buchanan                                              
|                     |  |                                                                      
|                     |  | Jeffrey D. Buchanan
Chief Financial Officer, Secretary, and Treasurer

56



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##### Table of Contents






THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                                  |  |      |     | 
|----------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                  |  | Page
|                                                                                                                  |  |     
|Independent Auditors Reports                                                                                     |  |      | F-2 | 
|                                                                                                                  |  |      |     | 
|Consolidated Balance Sheets as of December 31, 2001 and 2002                                                      |  |      | F-4 | 
|                                                                                                                  |  |      |     | 
|Consolidated Statements of Operations for the years ended
December 31, 2000, 2001 and 2002                        |  |      | F-5 | 
|                                                                                                                  |  |      |     | 
|Consolidated Statements of Stockholders Equity for the years
ended December 31, 2000, 2001 and 2002              |  |      | F-6 | 
|                                                                                                                  |  |      |     | 
|Consolidated Statements of Comprehensive Income (Loss) for the years
ended December 31, 2000, 2001 and 2002       |  |      | F-7 | 
|                                                                                                                  |  |      |     | 
|Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 2001 and 2002                        |  |      | F-8 | 
|                                                                                                                  |  |      |     | 
|Notes to Consolidated Financial Statements                                                                        |  |      | F-9 | 
|                                                                                                                  |  |      |     | 
|Schedule II  Valuation and Qualifying Accounts and Reserves
for the years ended December 31, 2000, 2001 and 2002 |  |      | S-1 | 

F-1



---



##### Table of Contents



INDEPENDENT AUDITORS REPORT

To the Stockholders and Board of Directors of Three-Five Systems, Inc.:

We have audited the accompanying consolidated balance sheet of Three-Five
Systems, Inc. and subsidiaries as of December 31, 2002, and the related
consolidated statements of operations, stockholders equity, comprehensive
income (loss) and cash flows for the year then ended. Our audit also included
the 2002 financial statement schedule listed in the Index. These financial
statements and the financial statement schedule are the responsibility of the
Companys management. Our responsibility is to express an opinion on the 2002
financial statements and the financial statement schedule based on our audit.
The financial statements and financial statement schedule as of December 31,
2001, and for each of the years in the two-year period then ended, were audited
by other auditors who have ceased operations. Those auditors expressed an
unqualified opinion on those financial statements and stated that such 2001 and
2000 financial statement schedules, when considered in relation to the 2001 and
2000 basic financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein, in their report dated
January 20, 2002.

We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.

In our opinion, the 2002 consolidated financial statements present fairly,
in all material respects, the financial position of Three-Five Systems, Inc.
and subsidiaries as of December 31, 2002, and the results of their operations
and their cash flows for the year then ended, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the 2002 financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.

/s/ DELOITTE & TOUCHE LLP

Phoenix, Arizona
February 3, 2003, except for Note 11,      as
to which the date is March 17, 2003.

F-2



---



##### Table of Contents



NOTE: The report of Arthur Andersen LLP presented below is a copy of a
previously issued Arthur Andersen LLP report. This report has not been
reissued by Arthur Andersen LLP, nor has Arthur Andersen LLP provided a consent
to the inclusion of its report in this Form 10-K.

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Three-Five Systems, Inc.:

We have audited the accompanying consolidated balance sheets of THREE-FIVE
SYSTEMS, INC. (the Company) (a Delaware corporation) and subsidiaries as of
December 31, 2000 and 2001, and the related consolidated statements of
operations, stockholders equity, comprehensive income (loss) and cash flows
for each of the three years in the period ended December 31, 2001. These
financial statements and the schedule referred to below are the responsibility
of the Companys management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company and
subsidiaries as of December 31, 2000 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.

Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed on the Index to
Consolidated Financial Statements is presented for purposes of complying with
the Securities and Exchange Commissions rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.

/s/ ARTHUR ANDERSEN LLP

Phoenix, Arizona
January 21, 2002

F-3



---



##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |         |         |         | 
|-------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | -------------------------- | ------- | ------------ | ------- | ------- | ------- | ------- | ------- | 
|                                             |                                                                                                                                                 |                           |                            |         | December 31,
|                                             |                                                                                                                                                 |                           |                            |         |             
|                                             |                                                                                                                                                 |                           |                            |         | 2001         |         | 2002   
|                                             |                                                                                                                                                 |                           |                            |         |              |         |        
|ASSETS                                       |                                                                                                                                                 |                           |                            |         |              |         |         |        
|Current Assets:                              |                                                                                                                                                 |                           |                            |         |              |         |         |        
|                                             | Cash and cash equivalents                                                                                                                       |                           | $                          | 37,003  |              |         | $       | 18,389  |        
|                                             | Short-term investments                                                                                                                          |                           |                            | 110,016 |              |         |         | 62,178  |        
|                                             | Accounts receivable, net                                                                                                                        |                           |                            | 18,102  |              |         |         | 16,970  |        
|                                             | Inventories                                                                                                                                     |                           |                            | 15,629  |              |         |         | 19,876  |        
|                                             | Income taxes receivable                                                                                                                         |                           |                            | 3,960   |              |         |         | 561     |        
|                                             | Deferred income tax asset                                                                                                                       |                           |                            | 3,930   |              |         |         | 3,561   |        
|                                             | Assets held for sale                                                                                                                            |                           |                            |        |              |         |         | 841     |        
|                                             | Other current assets                                                                                                                            |                           |                            | 2,104   |              |         |         | 2,507   |        
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|                                             |                                                                                                                                                 | Total current assets      |                            |         | 190,744      |         |         |         | 124,883 |        
|Long-term Investments                        |                                                                                                                                                 |                           | 9,034                      |         |              |         |        |        
|Property, Plant and Equipment, net           |                                                                                                                                                 |                           | 38,353                     |         |              |         | 31,563  |        
|Intangibles, net                             |                                                                                                                                                 |                           | 5,886                      |         |              |         | 14,919  |        
|Goodwill                                     |                                                                                                                                                 |                           |                           |         |              |         | 34,901  |        
|Long-term Deferred Income Tax Asset          |                                                                                                                                                 |                           | 219                        |         |              |         | 9,642   |        
|Other Investments                            |                                                                                                                                                 |                           | 1,250                      |         |              |         | 6,331   |        
|Other Assets                                 |                                                                                                                                                 |                           | 402                        |         |              |         | 455     |        
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|                                             |                                                                                                                                                 | $                         | 245,888                    |         |              | $       | 222,694 |        
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|LIABILITIES AND STOCKHOLDERS EQUITY         |                                                                                                                                                 |                           |                            |         |              |         |         |        
|Current Liabilities:                         |                                                                                                                                                 |                           |                            |         |              |         |         |        
|                                             | Accounts payable                                                                                                                                |                           | $                          | 14,785  |              |         | $       | 8,760   |        
|                                             | Accrued liabilities                                                                                                                             |                           |                            | 4,130   |              |         |         | 5,166   |        
|                                             | Deferred revenue                                                                                                                                |                           |                            |        |              |         |         | 358     |        
|                                             | Term loan                                                                                                                                       |                           |                            | 2,706   |              |         |         | 2,714   |        
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|                                             |                                                                                                                                                 | Total current liabilities |                            |         | 21,621       |         |         |         | 16,998  |        
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|Long-term Debt                               |                                                                                                                                                 |                           |                           |         |              |         | 20      |        
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|Other Long-term Liabilities                  |                                                                                                                                                 |                           |                           |         |              |         | 8       |        
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|Commitments and Contingencies (Note 8)       |                                                                                                                                                 |                           |                            |         |              |         |         |        
|Minority Interest in Consolidated Subsidiary |                                                                                                                                                 |                           | 323                        |         |              |         |        |        
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|Stockholders Equity:                        |                                                                                                                                                 |                           |                            |         |              |         |         |        
|                                             | Preferred stock, $.01 par value; 1,000,000 shares
authorized, no shares issued or outstanding                                                   |                           |                            |        |              |         |         |        |        
|                                             | Common stock, $.01 par value; 60,000,000 shares
authorized, 21,894,628 and 21,937,356 shares issued at
December 31, 2001 and 2002, respectively |                           |                            | 219     |              |         |         | 219     |        
|                                             | Additional paid-in capital                                                                                                                      |                           |                            | 200,395 |              |         |         | 200,763 |        
|                                             | Retained earnings                                                                                                                               |                           |                            | 30,666  |              |         |         | 13,695  |        
|                                             | Stock subscription note receivable                                                                                                              |                           |                            | (163    | )            |         |         | (174    | )      
|                                             | Accumulated other comprehensive loss                                                                                                            |                           |                            | (21     | )            |         |         | (332    | )      
|                                             | Less  Treasury stock, at cost, 390,717 shares at December
31, 2001 and 651,317 shares at December
31, 2002                                     |                           |                            | (7,152  | )            |         |         | (8,503  | )      
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|                                             |                                                                                                                                                 |                           | Total stockholders equity |         |              | 223,944 |         |         |         | 205,668 | 
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        
|                                             |                                                                                                                                                 | $                         | 245,888                    |         |              | $       | 222,694 |        
|                                             |                                                                                                                                                 |                           |                            |         |              |         |         |        

The accompanying notes are an integral part of these consolidated balance sheets.

F-4



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##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |         |         |  
|---------------------------------------------------- | ----------------------------------------- | ----------------------- | ------- | ------------ | ------ | ---- | ------- | ----------- | ------- | - | ------- | ------- | ------- | -
|                                                     |                                           |                         |         |              |        |      |         | Years Ended |         |   |         |        
|                                                     |                                           |                         |         | December 31,
|                                                     |                                           |                         |         |             
|                                                     |                                           |                         |         | 2000         |        | 2001 |         | 2002       
|                                                     |                                           |                         |         |              |        |      |         |            
|Net Sales                                            |                                           | $                       | 160,684 |              |        | $    | 119,136 |             |         | $ | 88,026  |        
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|Costs and Expenses:                                  |                                           |                         |         |              |        |      |         |             |         |   |         |        
|                                                     | Cost of sales                             |                         |         | 124,724      |        |      |         | 121,514     |         |   |         | 85,133  |        
|                                                     | Selling, general and administrative       |                         |         | 9,501        |        |      |         | 10,130      |         |   |         | 11,324  |        
|                                                     | Research, development and engineering     |                         |         | 13,295       |        |      |         | 17,618      |         |   |         | 17,968  |        
|                                                     | Write-down of assets held for sale        |                         |         |             |        |      |         |            |         |   |         | 4,545   |        
|                                                     | Amortization of customer lists            |                         |         |             |        |      |         |            |         |   |         | 256     |        
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|                                                     |                                           |                         | 147,520 |              |        |      | 149,262 |             |         |   | 119,226 |        
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|                                                     |                                           | Operating income (loss) |         |              | 13,164 |      |         |             | (30,126 | ) |         |         | (31,200 | )
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|Other Income (Expense):                              |                                           |                         |         |              |        |      |         |             |         |   |         |        
|                                                     | Interest, net                             |                         |         | 7,374        |        |      |         | 7,266       |         |   |         | 3,328   |        
|                                                     | Loss on investment in start-up company    |                         |         |             |        |      |         | (3,820      | )       |   |         |        |        
|                                                     | Other, net                                |                         |         | (190         | )      |      |         | 4           |         |   |         | 164     |        
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|                                                     |                                           |                         | 7,184   |              |        |      | 3,450   |             |         |   | 3,492   |        
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|Minority Interest in Loss of Consolidated Subsidiary |                                           |                         |        |              |        |      | 167     |             |         |   | 84      |        
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|Income (Loss) before Income Taxes                    |                                           |                         | 20,348  |              |        |      | (26,509 | )           |         |   | (27,624 | )      
|                                                     | Provision for (benefit from) income taxes |                         |         | 5,514        |        |      |         | (8,745      | )       |   |         | (10,653 | )      
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|Net Income (Loss)                                    |                                           | $                       | 14,834  |              |        | $    | (17,764 | )           |         | $ | (16,971 | )      
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|Earnings (Loss) Per Common Share:                    |                                           |                         |         |              |        |      |         |             |         |   |         |        
|                                                     | Basic                                     |                         | $       | 0.73         |        |      | $       | (0.83       | )       |   | $       | (0.79   | )      
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|                                                     | Diluted                                   |                         | $       | 0.69         |        |      | $       | (0.83       | )       |   | $       | (0.79   | )      
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|Weighted Average Number of Common Shares:            |                                           |                         |         |              |        |      |         |             |         |   |         |        
|                                                     | Basic                                     |                         |         | 20,457       |        |      |         | 21,401      |         |   |         | 21,465  |        
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        
|                                                     | Diluted                                   |                         |         | 21,636       |        |      |         | 21,401      |         |   |         | 21,465  |        
|                                                     |                                           |                         |         |              |        |      |         |             |         |   |         |        

The accompanying notes are an integral part of these consolidated financial statements.

F-5



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##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
For the Years Ended December 31, 2000, 2001 and 2002
(in thousands, except share data)

|                                               |  |               |            |            |  |          |     |              |  |               |         |               |  |               |         |        |  |       |      |             |  |   |      |   |  |   |        |   |  |   |         |  
|---------------------------------------------- |  | ------------- | ---------- | ---------- |  | -------- | --- | ------------ |  | ------------- | ------- | ------------- |  | ------------- | ------- | ------ |  | ----- | ---- | ----------- |  | - | ---- | - |  | - | ------ | - |  | - | ------- | -
|                                               |  |               |            |            |  |          |     |              |  |               |         |               |  |               |         |        |  | Stock |      | Accumulated |  |   |      |   |  |   |        |  
|                                               |  | Common Stock  |            | Additional |  |          |     | Subscription |  | Other         |         |               |  | Total        
|                                               |  |               |            | Paid-in    |  | Retained |     | Note         |  | Comprehensive |         | Treasury      |  | Stockholders
|                                               |  | Shares Issued |            | Amount     |  | Capital  |     | Earnings     |  | Receivable    |         | Income (Loss) |  | Stock         |         | Equity
|                                               |  |               |            |            |  |          |     |              |  |               |         |               |  |               |         |       
|Balance, December 31, 1999                     |  |               | 18,859,138 |            |  | $        | 189 |              |  | $             | 67,388  |               |  | $             | 33,639  |        |  | $     |     |             |  | $ | 7    |   |  | $ | (3     | ) |  | $ | 101,220 |  
|Net income                                     |  |               |           |            |  |          |    |              |  |               |        |               |  |               | 14,834  |        |  |       |     |             |  |   |     |   |  |   |       |   |  |   | 14,834  |  
|Foreign currency translation
adjustments       |  |               |           |            |  |          |    |              |  |               |        |               |  |               |        |        |  |       |     |             |  |   | (241 | ) |  |   |       |   |  |   | (241    | )
|Stock options exercised                        |  |               | 222,126    |            |  |          | 2   |              |  |               | 1,477   |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   |       |   |  |   | 1,479   |  
|Warrants exercised, net                        |  |               | 102,014    |            |  |          | 1   |              |  |               |        |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   |       |   |  |   | 1       |  
|Tax benefit on stock option
exercises          |  |               |           |            |  |          |    |              |  |               | 674     |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   |       |   |  |   | 674     |  
|Purchase of treasury stock                     |  |               |           |            |  |          |    |              |  |               |        |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   | (4,623 | ) |  |   | (4,623  | )
|Sale of common stock, net of
offering expenses |  |               | 2,472,500  |            |  |          | 25  |              |  |               | 128,676 |               |  |               | (43     | )      |  |       |     |             |  |   |     |   |  |   |       |   |  |   | 128,658 |  
|                                               |  |               |            |            |  |          |     |              |  |               |         |               |  |               |         |        |  |       |      |             |  |   |      |   |  |   |        |   |  |   |         |  
|Balance, December 31, 2000                     |  |               | 21,655,778 |            |  |          | 217 |              |  |               | 198,215 |               |  |               | 48,430  |        |  |       |     |             |  |   | (234 | ) |  |   | (4,626 | ) |  |   | 242,002 |  
|Net loss                                       |  |               |           |            |  |          |    |              |  |               |        |               |  |               | (17,764 | )      |  |       |     |             |  |   |     |   |  |   |       |   |  |   | (17,764 | )
|Unrealized gains on investments                |  |               |           |            |  |          |    |              |  |               |        |               |  |               |        |        |  |       |     |             |  |   | 260  |   |  |   |       |   |  |   | 260     |  
|Foreign currency translation
adjustments       |  |               |           |            |  |          |    |              |  |               |        |               |  |               |        |        |  |       |     |             |  |   | (47  | ) |  |   |       |   |  |   | (47     | )
|Stock subscription note receivable             |  |               |           |            |  |          |    |              |  |               | 410     |               |  |               |        |        |  |       | (163 | )           |  |   |     |   |  |   |       |   |  |   | 247     |  
|Stock options exercised and other              |  |               | 238,850    |            |  |          | 2   |              |  |               | 1,182   |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   |       |   |  |   | 1,184   |  
|Tax benefit on stock option
exercises          |  |               |           |            |  |          |    |              |  |               | 588     |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   |       |   |  |   | 588     |  
|Purchase of treasury stock                     |  |               |           |            |  |          |    |              |  |               |        |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   | (2,526 | ) |  |   | (2,526  | )
|                                               |  |               |            |            |  |          |     |              |  |               |         |               |  |               |         |        |  |       |      |             |  |   |      |   |  |   |        |   |  |   |         |  
|Balance, December 31, 2001                     |  |               | 21,894,628 |            |  |          | 219 |              |  |               | 200,395 |               |  |               | 30,666  |        |  |       | (163 | )           |  |   | (21  | ) |  |   | (7,152 | ) |  |   | 223,944 |  
|Net loss                                       |  |               |           |            |  |          |    |              |  |               |        |               |  |               | (16,971 | )      |  |       |     |             |  |   |      |   |  |   |       |   |  |   | (16,971 | )
|Unrealized losses on investments               |  |               |           |            |  |          |    |              |  |               |        |               |  |               |         |        |  |       |     |             |  |   | (197 | ) |  |   |       |   |  |   | (197    | )
|Foreign currency translation
adjustments       |  |               |           |            |  |          |    |              |  |               |        |               |  |               |        |        |  |       |     |             |  |   | (114 | ) |  |   |       |   |  |   | (114    | )
|Stock subscription note receivable             |  |               |           |            |  |          |    |              |  |               |        |               |  |               |        |        |  |       | (11  | )           |  |   |     |   |  |   |       |   |  |   | (11     | )
|Stock options exercised and other              |  |               | 42,728     |            |  |          |    |              |  |               | 323     |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   |       |   |  |   | 323     |  
|Tax benefit on stock option
exercises          |  |               |           |            |  |          |    |              |  |               | 45      |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   |       |   |  |   | 45      |  
|Purchase of treasury stock                     |  |               |           |            |  |          |    |              |  |               |        |               |  |               |        |        |  |       |     |             |  |   |     |   |  |   | (1,351 | ) |  |   | (1,351  | )
|                                               |  |               |            |            |  |          |     |              |  |               |         |               |  |               |         |        |  |       |      |             |  |   |      |   |  |   |        |   |  |   |         |  
|Balance, December 31, 2002                     |  |               | 21,937,356 |            |  | $        | 219 |              |  | $             | 200,763 |               |  | $             | 13,695  |        |  | $     | (174 | )           |  | $ | (332 | ) |  | $ | (8,503 | ) |  | $ | 205,668 |  
|                                               |  |               |            |            |  |          |     |              |  |               |         |               |  |               |         |        |  |       |      |             |  |   |      |   |  |   |        |   |  |   |         |  

The accompanying notes are an integral part of these consolidated financial statements.

F-6



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##### Table of Contents



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

For the Years Ended December 31, 2000, 2001 and 2002
(in thousands)

|                                                 |                                                                                                                         |                             |        |                          |        |      |         |      |         |   |         |      |         |  
|------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------- | --------------------------- | ------ | ------------------------ | ------ | ---- | ------- | ---- | ------- | - | ------- | ---- | ------- | -
|                                                 |                                                                                                                         |                             |        | Years Ended December 31,
|                                                 |                                                                                                                         |                             |        |                         
|                                                 |                                                                                                                         |                             |        | 2000                     |        | 2001 |         | 2002
|                                                 |                                                                                                                         |                             |        |                          |        |      |         |     
|Net Income (Loss)                                |                                                                                                                         | $                           | 14,834 |                          |        | $    | (17,764 | )    |         | $ | (16,971 | )   
|Other Comprehensive Income (Loss), net of
taxes: |                                                                                                                         |                             |        |                          |        |      |         |      |         |   |         |     
|                                                 | Unrealized gains (losses), net of tax
expense
(benefit) of $129 and ($96) as of
years ended 2001 and 2002, respectively |                             |        |                         |        |      |         | 260  |         |   |         | (197 | )      
|                                                 | Foreign currency translation adjustment                                                                                 |                             |        | (241                     | )      |      |         | (47  | )       |   |         | (114 | )      
|                                                 |                                                                                                                         |                             |        |                          |        |      |         |      |         |   |         |     
|                                                 |                                                                                                                         | Comprehensive income (loss) |        | $                        | 14,593 |      |         | $    | (17,551 | ) |         | $    | (17,282 | )
|                                                 |                                                                                                                         |                             |        |                          |        |      |         |      |         |   |         |     

The accompanying notes are an integral part of these consolidated financial statements.

F-7



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##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |        |         |         |  
|-------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------- | --------------------------------------------------------------- | --------------------------------------------------- | ----- | ------------ | -------- | -------- | ------ | ----------- | ------ | -------- | ------ | ------- | ------- | -
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        | Years Ended |        |          |        |        
|                                                                                                   |                                                                     |                                                                 |                                                     |       | December 31,
|                                                                                                   |                                                                     |                                                                 |                                                     |       |             
|                                                                                                   |                                                                     |                                                                 |                                                     |       | 2000         |          | 2001     |        | 2002       
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |            
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                              |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|Net income (loss)                                                                                  |                                                                     | $                                                               | 14,834                                              |       |              | $        | (17,764  | )      |             | $      | (16,971  | )     
|Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities: |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|                                                                                                   | Depreciation and amortization                                       |                                                                 |                                                     | 6,039 |              |          |          | 5,961  |             |        |          | 7,402  |        
|                                                                                                   | Stock compensation                                                  |                                                                 |                                                     |      |              |          |          |       |             |        |          | 104    |        
|                                                                                                   | Minority interest in consolidated subsidiary                        |                                                                 |                                                     |      |              |          |          | (167   | )           |        |          | (84    | )      
|                                                                                                   | Deferred revenue                                                    |                                                                 |                                                     |      |              |          |          |       |             |        |          | 358    |        
|                                                                                                   | Provision for (reduction of) accounts receivable valuation reserves |                                                                 |                                                     | (311  | )            |          |          | (180   | )           |        |          | 187    |        
|                                                                                                   | Write-down of assets held for sale                                  |                                                                 |                                                     |      |              |          |          |       |             |        |          | 4,545  |        
|                                                                                                   | Loss on disposal of assets                                          |                                                                 |                                                     | 74    |              |          |          | 1,371  |             |        |          |       |        
|                                                                                                   | Tax benefit on stock option exercises                               |                                                                 |                                                     | 674   |              |          |          | 588    |             |        |          | 45     |        
|                                                                                                   | Benefit from deferred taxes, net                                    |                                                                 |                                                     | (626  | )            |          |          | (4,575 | )           |        |          | (9,021 | )      
|                                                                                                   | Interest on officer loan                                            |                                                                 |                                                     |      |              |          |          | (10    | )           |        |          | (11    | )      
|                                                                                                   | Loss on investment in start-up company                              |                                                                 |                                                     |      |              |          |          | 3,820  |             |        |          |       |        
|                                                                                                   | Changes in assets and liabilities:                                  |                                                                 |                                                     |       |              |          |          |        |             |        |          |        |        
|                                                                                                   |                                                                     | (Increase) decrease in accounts receivable                      |                                                     |       | (2,438       | )        |          |        | 5,713       |        |          |        | 6,907   |        
|                                                                                                   |                                                                     | (Increase) decrease in inventories                              |                                                     |       | (8,172       | )        |          |        | 4,887       |        |          |        | 8,733   |        
|                                                                                                   |                                                                     | (Increase) decrease in other assets                             |                                                     |       | (941         | )        |          |        | (339        | )      |          |        | 124     |        
|                                                                                                   |                                                                     | Increase (decrease) in accounts payable and accrued liabilities |                                                     |       | (2,567       | )        |          |        | 506         |        |          |        | (15,893 | )      
|                                                                                                   |                                                                     | Increase (decrease) in taxes payable/receivable                 |                                                     |       | (497         | )        |          |        | (3,914      | )      |          |        | 3,397   |        
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|                                                                                                   |                                                                     |                                                                 | Net cash provided by (used in) operating activities |       |              | 6,069    |          |        |             | (4,103 | )        |        |         | (10,178 | )
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                              |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|Purchase of property, plant and equipment                                                          |                                                                     |                                                                 | (8,279                                              | )     |              |          | (6,843   | )      |             |        | (4,631   | )     
|Proceeds from sale of asset                                                                        |                                                                     |                                                                 |                                                    |       |              |          |         |        |             |        | 2,100    |       
|Purchase of intangibles                                                                            |                                                                     |                                                                 | (528                                                | )     |              |          | (1,474   | )      |             |        | (5,992   | )     
|Purchase of investments                                                                            |                                                                     |                                                                 | (738,888                                            | )     |              |          | (222,619 | )      |             |        | (102,591 | )     
|Proceeds from maturities of investments                                                            |                                                                     |                                                                 | 614,428                                             |       |              |          | 228,289  |        |             |        | 159,233  |       
|Payments on stock subscription note receivable                                                     |                                                                     |                                                                 |                                                    |       |              |          | 257      |        |             |        |         |       
|Acquisitions                                                                                       |                                                                     |                                                                 |                                                    |       |              |          |         |        |             |        | (50,089  | )     
|Other investments                                                                                  |                                                                     |                                                                 | (500                                                | )     |              |          | (1,250   | )      |             |        | (5,081   | )     
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|                                                                                                   |                                                                     |                                                                 | Net cash used in investing activities               |       |              | (133,767 | )        |        |             | (3,640 | )        |        |         | (7,051  | )
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                              |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|Net proceeds from (payments on) notes payable to banks                                             |                                                                     |                                                                 | 2,706                                               |       |              |          |         |        |             |        |         |       
|Stock options and warrants exercised                                                               |                                                                     |                                                                 | 1,480                                               |       |              |          | 1,184    |        |             |        | 210      |       
|Minority interest                                                                                  |                                                                     |                                                                 |                                                    |       |              |          | 490      |        |             |        | (239     | )     
|Purchase of treasury stock                                                                         |                                                                     |                                                                 | (4,623                                              | )     |              |          | (2,526   | )      |             |        | (1,351   | )     
|Net proceeds from equity offering                                                                  |                                                                     |                                                                 | 128,658                                             |       |              |          |         |        |             |        |         |       
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|                                                                                                   |                                                                     |                                                                 | Net cash provided by (used in) financing activities |       |              | 128,221  |          |        |             | (852   | )        |        |         | (1,380  | )
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|Effect of exchange rate changes on cash and cash equivalents                                       |                                                                     |                                                                 | (241                                                | )     |              |          | (47      | )      |             |        | (5       | )     
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                               |                                                                     |                                                                 | 282                                                 |       |              |          | (8,642   | )      |             |        | (18,614  | )     
|CASH AND CASH EQUIVALENTS, beginning of year                                                       |                                                                     |                                                                 | 45,363                                              |       |              |          | 45,645   |        |             |        | 37,003   |       
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|CASH AND CASH EQUIVALENTS, end of year                                                             |                                                                     | $                                                               | 45,645                                              |       |              | $        | 37,003   |        |             | $      | 18,389   |       
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|SUPPLEMENTAL CASH FLOW INFORMATION:                                                                |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|Interest paid                                                                                      |                                                                     | $                                                               | 751                                                 |       |              | $        | 201      |        |             | $      | 178      |       
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       
|Income taxes paid (refunded)                                                                       |                                                                     | $                                                               | 6,197                                               |       |              | $        | (808     | )      |             | $      | (5,088   | )     
|                                                                                                   |                                                                     |                                                                 |                                                     |       |              |          |          |        |             |        |          |       

The accompanying notes are an integral part of these consolidated financial statements.

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THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 2001 and 2002

(1) Organization and Operations:

We offer advanced design and manufacturing services to original equipment
manufacturers, commonly referred to as OEMs. We have two business segments.
The first segment is referred to as the Integrated Systems and Displays, or
ISD. In that segment, we focus on display products and our electronic
manufacturing services. We specialize in custom and standard display modules
utilizing various display technologies, including liquid crystal displays,
LCDs, organic light emitting displays, or OLEDs, and cathode ray tubes, or
CRTs. Our display modules are of varying sizes and have varying levels of
integration. At a minimum, each display module includes a display, a custom
driver, and a flexible connector. We also provide ruggedized and customized
monitors. We also provide value-added services, which increase our
competitiveness, by assembling additional components onto the module based upon
the specific needs of the customer. These additional components may include
such items as keypads, microphones, speakers, light guides, and optics. Late in
2002, we expanded the value-added manufacturing services we provide in the ISD
segment through our acquisition of ETMA Corporation. As a result of that
acquisition, we now provide printed circuit board assembly, or PCBA, and box
build capabilities to customers, even in products that do not need displays.

In our second business segment, referred to as the Microdisplay segment,
we offer a range of LCoSproduct solutions with different levels of integration
from individual images to optical light engines. The focused markets for our
LCoSmicrodisplay products are large screen television sets, front projectors,
and near-to-eye or personal display system applications.

Three-Five Systems Limited (Limited), a wholly owned subsidiary, is
incorporated in the United Kingdom. Limited sells and distributes our products
to customers on the European continent.

Three-Five Systems Pacific, Inc. (Pacific), a wholly owned Philippines
corporation, manufactures our products.

Three-Five Systems (Beijing) Co., Ltd. (Beijing), a wholly owned
subsidiary, manufactures and sells our products to customers primarily located
in Asia.

ETMA Corporation (ETMA), a wholly owned subsidiary, is incorporated in
Redmond, Washington and specializes in manufacturing services to OEMs.

(2) Summary of Significant Accounting Policies:

Principles of Consolidation and Preparation of Financial Statements

The consolidated financial statements include our accounts and those of
our subsidiaries. All material intercompany transactions and balances have been
eliminated.

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, we evaluate our estimates
and judgments, including those related to bad debts, inventories, investments,
fixed assets, intangible assets, income taxes, pensions, and contingencies. We
base our estimates on historical experience and on various other assumptions
that we believe are reasonable under the circumstances. The results form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results could differ
from those estimates.

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Concentration of Credit Risk

Our strategy involves concentrating our efforts on providing design and
production services to leading companies in a limited number of fast-growing
industries. We have been undertaking substantial efforts to diversify our
business, broaden our customer base, and expand our markets. Product sales for
our historical major customer, Motorola, accounted for approximately 87%, 85%
and 77% of our net sales in 2000, 2001 and 2002, respectively. Sales to
Motorola primarily consisted of mobile handset applications sold by our ISD
operating segment. Since 2000, no other customer has accounted for more than
10% of our net sales. A significant decline in sales to Motorola is expected
to occur in 2003 primarily as a result of our receiving no new design wins in
2001 or 2002 for Motorolas handset business.

The significant amount of sales to a few customers results in certain
concentrations of credit risk for us. Our accounts receivable balance at
December 31, 2000, 2001 and 2002 included 76%, 77%, and 27%, respectively, from
Motorola. The significant drop in concentration was due to the much lower
concentration of sales in the fourth quarter to Motorola (55%) and due to the
acquisition of accounts receivable balances from the purchase of ETMA. The
remaining accounts receivable balances are mainly related to customers from our
ISD operating segment. These customers are located primarily in the United
States, Asia, and Europe.

Fair Value of Financial Instruments

We have determined the estimated fair value of financial instruments
using available market information and valuation methodologies.
Estimating fair values requires considerable judgment. Accordingly, the
estimates may not be indicative of
amounts that would be realized in a current market exchange. The carrying
values of cash, accounts receivable, and accounts payable approximate
fair value due to the short maturities of these instruments. In addition,
at December 31, 2002, the carrying amount on the term loan is estimated
to approximate fair value as the actual interest rate is consistent with
rates estimated to be currently available for debt with similar terms and
remaining maturities.

Cash and Cash Equivalents

For purposes of the statements of cash flows, all highly liquid
investments with an original maturity of three months or less are considered to
be cash equivalents. Cash equivalents consist of investments in marketable debt securities, money market mutual funds, and U.S.
government agencies obligations. A portion of our funds held in money market
mutual funds are invested in repurchase agreements. These repurchase
agreements are collateralized by U.S. Treasury and Government obligations.
Cash and cash equivalents at December 31 consists of the following (in
thousands):

|                           |                                   |   |              |        |      |   |        |        | 
|-------------------------- | --------------------------------- | - | ------------ | ------ | ---- | - | ------ | ------ | 
|                           |                                   |   | December 31,
|                           |                                   |   |             
|                           |                                   |   | 2001         |        | 2002
|                           |                                   |   |              |        |     
|Cash and cash equivalents: |                                   |   |              |        |      |   |        |       
|                           | Cash                              |   | $            | 6,992  |      |   | $      | 12,513 | 
|                           | Certificates of deposit           |   |              | 5,014  |      |   |        |       | 
|                           | Money market                      |   |              | 10,044 |      |   |        | 5,876  | 
|                           | U.S. government agency securities |   |              | 7,445  |      |   |        |       | 
|                           | Corporate notes and bonds         |   |              | 7,508  |      |   |        |       | 
|                           |                                   |   |              |        |      |   |        |       
|                           |                                   | $ | 37,003       |        |      | $ | 18,389 |       
|                           |                                   |   |              |        |      |   |        |       

Accounts Receivable, net

Allowance for doubtful accounts was $259,000 and $446,000, as of December
31, 2001 and 2002, respectively.

Investments

Short-term investments have original maturities greater than three months
and remaining maturities of less than one year. Debt securities with remaining
maturities greater than one year are classified as long-term investments. All
short-term and long-term investments are classified as available for sale and
are presented at market value using

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the specific identification method based on
quoted market prices. Unrealized gains and losses are reflected in other
comprehensive
income. Realized gains and losses are included in results of operations.
Short-term and long-term investments consist of the following at (in
thousands):

|                        |                                   |   |              |        |      |   |        |        | 
|----------------------- | --------------------------------- | - | ------------ | ------ | ---- | - | ------ | ------ | 
|                        |                                   |   | December 31,
|                        |                                   |   |             
|                        |                                   |   | 2001         |        | 2002
|                        |                                   |   |              |        |     
|Short-term investments: |                                   |   |              |        |      |   |        |       
|                        | Certificates of deposit           |   | $            | 14,970 |      |   | $      | 11,498 | 
|                        | Corporate notes and bonds         |   |              | 63,883 |      |   |        | 40,056 | 
|                        | U.S. government agency securities |   |              | 28,967 |      |   |        | 10,624 | 
|                        | Commercial paper                  |   |              | 2,196  |      |   |        |       | 
|                        |                                   |   |              |        |      |   |        |       
|                        |                                   | $ | 110,016      |        |      | $ | 62,178 |       
|                        |                                   |   |              |        |      |   |        |       

|                       |                           |  |              |       |      |  |   |   | 
|---------------------- | ------------------------- |  | ------------ | ----- | ---- |  | - | - | 
|                       |                           |  | December 31,
|                       |                           |  |             
|                       |                           |  | 2001         |       | 2002
|                       |                           |  |              |       |     
|Long-term investments: |                           |  |              |       |      |  |   |  
|                       | Corporate notes and bonds |  | $            | 9,034 |      |  | $ |  | 
|                       |                           |  |              |       |      |  |   |  

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or net
realizable value and consist of the following at (in thousands):

|                |  |              |        |      |  |   |        | 
|--------------- |  | ------------ | ------ | ---- |  | - | ------ | 
|                |  | December 31,
|                |  |             
|                |  | 2001         |        | 2002
|                |  |              |        |     
|Raw materials   |  | $            | 11,535 |      |  | $ | 13,428 | 
|Work-in-process |  |              | 964    |      |  |   | 2,913  | 
|Finished goods  |  |              | 3,130  |      |  |   | 3,535  | 
|                |  |              |        |      |  |   |        | 
|                |  | $            | 15,629 |      |  | $ | 19,876 | 
|                |  |              |        |      |  |   |        | 

We write down inventories for estimated obsolescence or unmarketable inventory
to estimated market value based upon assumptions about future demand and market
conditions. If actual market conditions are less favorable than those
projected, then additional inventory write-downs may be required.

Property, Plant, and Equipment

Property, plant, and equipment is recorded at cost and is depreciated
using the straight-line method over the estimated useful lives of the
respective assets. Lives for the major asset categories are:

|                      |  |             |  | 
|--------------------- |  | ----------- |  | 
|                      |  | Lives      
|                      |  |            
|Buildings             |  | 39 years   
|Building Improvements |  | 1538 years
|Equipment             |  | 37 years  
|Furniture             |  | 510 years 

Major additions and betterments are capitalized, while replacements, maintenance, and repairs that do not extend the useful lives of the assets are charged to operations as incurred. Depreciation expense totaled $6,024,000,
$5,212,000, and $5,443,000 for the years ended December 31, 2000, 2001, and
2002, respectively. Property, plant, and equipment consist of the following at
(in thousands):

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|                              |  |              |         |      |  |   |         |  
|----------------------------- |  | ------------ | ------- | ---- |  | - | ------- | -
|                              |  | December 31,
|                              |  |             
|                              |  | 2001         |         | 2002
|                              |  |              |         |     
|Building and improvements     |  | $            | 16,476  |      |  | $ | 16,476  |  
|Furniture and equipment       |  |              | 53,728  |      |  |   | 47,806  |  
|                              |  |              |         |      |  |   |         |  
|                              |  |              | 70,204  |      |  |   | 64,282  |  
|Less accumulated depreciation |  |              | (31,851 | )    |  |   | (32,719 | )
|                              |  |              |         |      |  |   |         |  
|                              |  | $            | 38,353  |      |  | $ | 31,563  |  
|                              |  |              |         |      |  |   |         |  

In 1994, we conveyed our Tempe, Arizona, facility and certain improvements
to the City of Tempe as consideration for a rent-free 75-year lease. We have
the option to repurchase the facility for $1,000 after ten years; therefore,
the building lease is accounted for as a capital lease.

Other Investments

At December 31, 2002, other assets consist primarily of investments, at
cost, in two start-up companies: ColorLink, Inc. for $5.1 million and Silicon
Bandwidth, Inc. for $1.25 million.

In July 2002, we invested $5.0 million in Series B Preferred Stock of
ColorLink, Inc. which is convertible at anytime to common stock of ColorLink at
a conversion price of $10 per share. ColorLink develops and manufactures color
management technologies for LCoS microdisplays. ColorLinks products consist
of color management components and system architectures that are critical for
digital projection systems that use high-resolution microdisplays. Those
projection systems include color monitors, high-definition televisions and
multi-media projectors. This investment furthers our efforts to accelerate as
much as possible the establishment of the necessary infrastructure for LCoS
microdisplays. Our investment in ColorLink is accounted for under the cost
method as our ownership is less than 20% and we do not exert significant
influence. An additional $81,000 was recorded as investment in ColorLink
during the third quarter of 2002 for legal and due diligence expenses.

In 2001, we invested $1.25 million in Series B Preferred Stock of Silicon
Bandwidth, Inc., a privately held company. We are working closely with Silicon
Bandwidth to design unique, cost-effective, reconfigurable packaging platforms
for LCoSmicrodisplays. Our investment in Silicon Bandwidth is accounted for
under the cost method as our ownership is less than 20% and we do not exert
significant influence.

In April 1998, we entered into a strategic relationship with Inviso, Inc.,
a privately held company with numerous patents and proprietary technology
related to microdisplay development. We acquired a total minority equity
interest in Inviso of approximately $3.8 million. In the second quarter of
2001, we wrote off our investment of $3.8 million in Inviso because we
determined that our investment was impaired, as that term is defined under
generally accepted accounting principles. Subsequent to our write-off, Inviso
was unable to raise funds to operate its business and has since ceased
operations. In the second quarter of 2002, we purchased all of the intellectual
property of Inviso for $780,000.

Intangibles

Intangibles consist of mask works, patents, licenses, customer lists and
other intangible assets. Intangibles are recorded at cost and amortized using
the straight-line method over the estimated useful lives of the respective
assets, which range from two to five years. Our policy is to commence
amortization of intangibles when their related benefits begin to be realized.
In January 2002, we purchased the intellectual property of Zight Corporation, a
private company focused on microdisplays for personal display system
applications, for $2.0 million. In April 2002, we purchased the intellectual
property of Inviso, Inc. for $780,000. In each case, the intellectual property
purchased consisted of patents, patents pending, and patent disclosures. In
September 2002, $3.0 million was allocated to customer lists through the
acquisition of AVT Advanced Video Technologies, of AVT, as described in Note 3.
In December 2002, $2.0 million was allocated to customer lists through the
acquisition of ETMA Corporation, as described in Note 3. Intangible assets as
of the year ended December 31, 2002 consist of the following (in thousands):

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|                             |                                     |   |             |       |              |   |        |        |   |   |        |       | 
|---------------------------- | ----------------------------------- | - | ----------- | ----- | ------------ | - | ------ | ------ | - | - | ------ | ----- | 
|                             |                                     |   | Acquisition |       | Accumulated  |   | Book  
|                             |                                     |   | Value       |       | Amortization |   | Value 
|                             |                                     |   |             |       |              |   |       
|Amortized Intangible Assets: |                                     |   |             |       |              |   |        |        |   |   |        |      
|                             | Mask works                          |   | $           | 6,242 |              |   | $      | (1,655 | ) |   | $      | 4,587 | 
|                             | Patents and other
intangible assets |   |             | 3,431 |              |   |        |       |   |   |        | 3,431 | 
|                             | Customer lists                      |   |             | 5,000 |              |   |        | (256   | ) |   |        | 4,744 | 
|                             | Licenses                            |   |             | 2,954 |              |   |        | (797   | ) |   |        | 2,157 | 
|                             |                                     |   |             |       |              |   |        |        |   |   |        |      
|                             |                                     | $ | 17,627      |       |              | $ | (2,708 | )      |   | $ | 14,919 |      
|                             |                                     |   |             |       |              |   |        |        |   |   |        |      

Intangible asset amortization expense for the year ended December 31, 2001
was $749,000. This expense was all recognized as cost of sales as it was
related to mask works on components purchased and production licenses employed
to build and sell microdisplay units during 2001. Intangible asset
amortization expense for the year ended December 31, 2002 was $2.0 million.
$1.7 million of this expense was recognized as cost of sales as it was related
to mask works on components purchased and production licenses employed to build
and sell microdisplay units during 2002. $256,000 of this expense was recorded
as operating expenses under Amortization
of Customer Lists as this amortization was related to intangible customer lists
acquired during the acquisitions of AVT and ETMA.

Estimated annual amortization expense through 2007 and thereafter related
to intangible assets reported as of December 31, 2002 is as follows (in
thousands):

|            |  |   |        | 
|----------- |  | - | ------ | 
|Fiscal Year |  |   |        | 
|            |  |   |        | 
|2003        |  | $ | 3,503  | 
|2004        |  |   | 3,846  | 
|2005        |  |   | 3,833  | 
|2006        |  |   | 2,552  | 
|2007        |  |   | 1,076  | 
|Thereafter  |  |   | 109    | 
|            |  |   |        | 
|            |  | $ | 14,919 | 
|            |  |   |        | 

Evaluation of Long-Lived Assets with Definite Lives

In accordance with Financial Accounting Standards Board (FASB) Statement
of Financial Accounting Standards (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, we evaluate the recoverability
of property, plant and equipment and intangibles with definite lives not held
for sale by comparing the carrying amount of the asset or group of assets
against the estimated undiscounted future cash flows expected to result from
the use of the asset or group of assets and their eventual disposition. If the
undiscounted cash flows are less than the carrying value of the asset or group
of assets being evaluated, an impairment loss is recorded. These cash flows
are evaluated for objectivity by using weighted probability techniques and also
comparisons of past performance against projections. Assets may also be
evaluated by identifying independent market values. The loss is measured as
the difference between the fair value and carrying value of the asset or group
of assets being evaluated. Assets to be disposed of are reported at the lower
of the carrying amount or the fair value less cost to sell. The estimated fair
value is based on the best information available under the circumstances,
including prices for similar assets or the results of valuation techniques,
including the present value of expected future cash flows using a discount rate
commensurate with the risks involved.

Goodwill

Our goodwill consists of goodwill from the purchases of Advanced Video
Technologies AVT and ETMA. The acquisition of AVT generated $7.8 million of
goodwill while the acquisition of ETMA created $27.1 million of goodwill. See
Note 3 for further explanations regarding the acquisitions.

Goodwill is analyzed for impairment, on at least an annual basis, or more
frequently if events or change in circumstances indicate that the asset might
be impaired. The impairment test consists of a comparison of the fair value of
the goodwill to its carrying amount in accordance with SFAS No. 142, Goodwill
and Other Intangible Assets.

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Accrued Liabilities

Accrued liabilities include, among other things, accrued compensation of
approximately $2,000,000 and $2,388,000 at December 31, 2001 and 2002,
respectively.

Income Taxes

Financial Accounting Standards Board (FASB) Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting for Income Taxes,requires the
use of an asset and liability approach in accounting for income taxes. Deferred
tax assets and liabilities are recorded based on the differences between the
financial statement and tax bases of assets and liabilities and the tax rates
in effect when these differences are expected to reverse.

Foreign Currency Translation

Financial information relating to our foreign subsidiaries is reported in
accordance with SFAS No. 52, Foreign Currency Translation. The functional
currency of Pacific is the Philippine peso. The gain or loss resulting from
the translation of Pacifics financial statements has been included as a
separate component of stockholders equity. Non-U.S. assets and liabilities
are translated into U.S. dollars using the year-end exchange rates. Revenues
and expenses are translated at average rates during the year.

The functional currency of Beijing is the Chinese renminbi. The gain or
loss resulting from the translation of Beijings financial statements has been
included as a separate component of stockholders equity. Non-U.S. assets and
liabilities are translated into U.S. dollars using the year-end exchange rates.
Revenues and expenses are translated at average rates during the year.

The functional currency of Limited continues to be the U.S. dollar.

The net foreign currency transaction loss in 2000 and 2001 was $96,000 and
$20,000, respectively. During 2002, we recorded a net foreign currency
transaction gain of $154,000. For all years, the loss or gain has been
included in the other expenses in the accompanying statements of income.

Derivatives

On January 1, 2001, we adopted SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which establishes accounting and reporting
standards requiring us to recognize derivatives as either assets or liabilities
on the balance sheet and to measure those instruments at fair value. The
adoption of SFAS No. 133 did not have a material impact on our financial
position or results of operation.

We use derivatives to manage exposures to foreign currency fluctuations.
The only type of derivative we use is foreign currency forward contracts. Our
objectives for holding these
forward contracts are to decrease the potential volatility of earnings and cash
flows associated with changes in foreign currency exchange rates (see Note 8).

Revenue Recognition

We recognize sales when persuasive evidence of a sale exists; that is, a
product is shipped under an agreement with a customer, risk of loss and title
have passed to the customer, the fee is fixed or determinable, and collection
of the resulting receivable is reasonably assured. Sales allowances are
estimated based upon historical experience of sales returns or pricing
concessions. We recognize revenue related to engineering and tooling services
after service has been rendered, which is determined based upon completion of
agreed upon milestones or deliverables.

We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. We
determine the adequacy of this allowance by regularly evaluating individual
customer receivables and considering a customers financial condition, credit
history, and current economic conditions. If the financial condition of our
customers were to deteriorate, additional allowances may be required.

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##### Table of Contents



At December 31, 2002, we had deferred revenue of $358,000.

Research, Development, and Engineering

We perform internal research, development, and engineering activities, as
well as research, development, and engineering activities contracted by our
customers. Research, development, and engineering costs are expensed as
incurred. Internal research, development, and engineering costs are included
as a component of research, development, and engineering expenses. Research,
development, and engineering costs of customer contracted research,
development, and engineering activities are included in cost of goods sold.
Revenue and expenses from funded contracts were each approximately
$500,000 in the year ended December 31, 2002.
There were no funded contracts for the years ended December 31, 2000 and 2001.

Stock Compensation

Pursuant to the provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, we account for options granted to our employees pursuant to
Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued
to Employees, under which no compensation cost has been recognized. However, we
have computed, for pro forma disclosure purposes, the value of all options
granted during 2000, 2001 and 2002, using the Black-Scholes option pricing
method with the following weighted assumptions: risk-free interest rates of
4.75%, 4.42%, and 2.74%; expected dividend yields of zero; expected lives of
6.2, 6.1, and 6.1 years; and expected volatility (a measure of the amount by
which a price has fluctuated or is expected to fluctuate during a period) of
72.6%, 74.5%, and 74.4%, respectively. Had compensation cost for these plans
been
determined consistent with SFAS No. 123, our net income and earnings per share
would have been as follows:

|                                     |                                                                                                                             |  |                                       |        |      |  |      |         |   |  |   |         |  
|------------------------------------ | --------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ------ | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                     |                                                                                                                             |  | Years Ended December 31,             
|                                     |                                                                                                                             |  |                                      
|                                     |                                                                                                                             |  | 2000                                  |        | 2001 |  | 2002
|                                     |                                                                                                                             |  |                                       |        |      |  |     
|                                     |                                                                                                                             |  | (in thousands, except per share data)
|                                     |                                                                                                                             | 
|Net income (loss):                   |                                                                                                                             |  |                                       |        |      |  |      |         |   |  |   |        
|                                     | As reported                                                                                                                 |  | $                                     | 14,834 |      |  | $    | (17,764 | ) |  | $ | (16,971 | )
|                                     | Total stock-based compensation
expenses determined under fair
value based method for all
awards, net of related tax
affects |  |                                       | (1,834 | )    |  |      | (3,223  | ) |  |   | (4,378  | )
|                                     |                                                                                                                             |  |                                       |        |      |  |      |         |   |  |   |        
|                                     | Pro forma net income (loss)                                                                                                 |  | $                                     | 13,000 |      |  | $    | (20,987 | ) |  | $ | (21,349 | )
|                                     |                                                                                                                             |  |                                       |        |      |  |      |         |   |  |   |        
|Basic net income (loss) per share:   |                                                                                                                             |  |                                       |        |      |  |      |         |   |  |   |        
|                                     | As reported                                                                                                                 |  | $                                     | 0.73   |      |  | $    | (0.83   | ) |  | $ | (0.79   | )
|                                     | Pro forma                                                                                                                   |  |                                       | 0.64   |      |  |      | (0.98   | ) |  |   | (0.99   | )
|Diluted net income (loss) per share: |                                                                                                                             |  |                                       |        |      |  |      |         |   |  |   |        
|                                     | As reported                                                                                                                 |  | $                                     | 0.69   |      |  | $    | (0.83   | ) |  | $ | (0.79   | )
|                                     | Pro forma                                                                                                                   |  |                                       | 0.60   |      |  |      | (0.98   | ) |  |   | (0.99   | )

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Earnings Per Share

Basic net income (loss) per common share is computed by dividing net
income (loss) by the weighted average number of common shares outstanding
during the year before giving effect to stock options and warrants considered
to be dilutive common stock equivalents. Diluted net income (loss) per common
share is computed by dividing net income (loss) by the weighted average number
of common shares outstanding during the year after giving effect to stock
options and warrants considered to be dilutive common stock equivalents. Set
forth below are the disclosures required pursuant to SFAS No. 128  Earnings
per Share:

|                                   |                                                   |                                          |        |              |      |      |         |        |       |   |         |        |       |  
|---------------------------------- | ------------------------------------------------- | ---------------------------------------- | ------ | ------------ | ---- | ---- | ------- | ------ | ----- | - | ------- | ------ | ----- | -
|                                   |                                                   |                                          |        | Years Ended 
|                                   |                                                   |                                          |        | December 31,
|                                   |                                                   |                                          |        |             
|                                   |                                                   |                                          |        | 2000         |      | 2001 |         | 2002  
|                                   |                                                   |                                          |        |              |      |      |         |       
|Basic earnings (loss) per share:   |                                                   |                                          |        |              |      |      |         |        |       |   |         |       
|Net income (loss)                  |                                                   | $                                        | 14,834 |              |      | $    | (17,764 | )      |       | $ | (16,971 | )     
|                                   |                                                   |                                          |        |              |      |      |         |        |       |   |         |       
|                                   | Weighted average common shares                    |                                          |        | 20,457       |      |      |         | 21,401 |       |   |         | 21,465 |      
|                                   |                                                   |                                          |        |              |      |      |         |        |       |   |         |       
|                                   |                                                   | Basic earnings (loss) per share amount   |        | $            | 0.73 |      |         | $      | (0.83 | ) |         | $      | (0.79 | )
|                                   |                                                   |                                          |        |              |      |      |         |        |       |   |         |       
|Diluted earnings (loss) per share: |                                                   |                                          |        |              |      |      |         |        |       |   |         |       
|Net income (loss)                  |                                                   | $                                        | 14,834 |              |      | $    | (17,764 | )      |       | $ | (16,971 | )     
|                                   |                                                   |                                          |        |              |      |      |         |        |       |   |         |       
|                                   | Weighted average common shares                    |                                          |        | 20,457       |      |      |         | 21,401 |       |   |         | 21,465 |      
|                                   | Options and warrants assumed exercised            |                                          |        | 1,179        |      |      |         |       |       |   |         |       |      
|                                   |                                                   |                                          |        |              |      |      |         |        |       |   |         |       
|                                   | Total common shares plus common stock
equivalents |                                          |        | 21,636       |      |      |         | 21,401 |       |   |         | 21,465 |      
|                                   |                                                   |                                          |        |              |      |      |         |        |       |   |         |       
|                                   |                                                   | Diluted earnings (loss) per share amount |        | $            | 0.69 |      |         | $      | (0.83 | ) |         | $      | (0.79 | )
|                                   |                                                   |                                          |        |              |      |      |         |        |       |   |         |       

For the years ended December 31, 2001 and 2002, the effect of 577,431 and
314,569 shares, respectively, were excluded from the calculation of loss per
share as their effect would have been antidilutive and decreased the loss per
share.

Recently Issued Accounting Standards

In September 2001, the FASB issued SFAS No. 141, Business Combinations,
and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141
requires companies to apply the purchase method of accounting for all business
combinations initiated after June 30, 2001 and prohibits the use of the
pooling-of-interest method. SFAS No. 142 requires identifiable intangible
assets to be recognized separately from goodwill. In addition, it eliminates
the amortization of all existing and newly acquired goodwill on a prospective
basis and requires companies to assess goodwill for impairment, at least
annually, based on the fair value of the reporting unit. We adopted SFAS Nos.
141 and 142 on January 1, 2002, and there was no material impact on our
financial position or results of operations.

In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and the accounting and reporting provisions of APB
Opinion No. 30, Reporting the Results of Operations  Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions. SFAS No. 144 modifies the
method in which companies account for certain asset impairment losses. We
adopted SFAS No. 144 on January 1, 2002 and there was no material impact on our
financial position or results of operations.

In July 2001, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 replaces EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring), and will apply to exit or disposal
activities initiated after December 31, 2002. We have reviewed the requirements
of SFAS No. 146 and believe the adoption of this statement will not have a
material impact on our financial statements.

In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based CompensationTransition and Disclosure. This Statement amends
SFAS No. 123 to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. Specifically, SFAS No. 148 prohibits companies from utilizing
the prospective method of transition, the only method offered under the
original

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SFAS No. 123, in fiscal years beginning after December 15, 2003.
However, the statement permits two additional transition methods for companies
that adopt the fair value method of accounting for stock-based compensation,
which include the modified prospective and retroactive restatement methods.
Under the prospective method, expense is recognized for all employee awards
granted, modified, or settled after the beginning of the fiscal year in which
the recognition provisions are first applied. The modified prospective method
recognizes stock-based employee compensation cost from the beginning of the
fiscal year in which the provisions are first applied, as if the fair value
method had been used to account for all employee awards granted, modified, or
settled in fiscal years beginning after December 15, 1994. Under the
retroactive restatement method, all periods presented are restated to reflect
stock-based employee compensation cost under the fair value method for all
employee awards granted, modified, or settled in fiscal years beginning after
December 15, 1994. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results
using a prescribed specific tabular format and requiring disclosure in the
Summary of Significant Accounting Policies or its equivalent. We have
adopted the new disclosure requirements for 2002, and are currently evaluating
the impact if we were to adopt the fair value method of accounting for
stock-based employee compensation under all three methods.

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. This Interpretation addresses
the disclosures to be made by a guarantor in its financial statements and its
obligations under guarantees. The Interpretation also clarifies the
requirements related to the recognition of a liability by the guarantor at the
inception of a guarantee. Per the interpretation, initial recognition of a
liability shall be applied only on a prospective basis to guarantees issued or
modified after December 31, 2002. We have reviewed the requirements of FIN 45
and believe the adoption of this interpretation will not have a material impact
on our financial statements.

Minority Interest

During 2001, we formed a new subsidiary, Three-D OLED L.L.C., that was
partially owned by Dupont Displays. We consolidated this subsidiary with
Duponts ownership accounted for as a minority interest. In the second quarter
of 2002, we agreed with Dupont Displays to liquidate Three-D OLED L.L.C., and
enter into a non-equity based Strategic Manufacturing and Supply Agreement.
Under that agreement, the parties will continue to work together in a fashion
similar to the venture, but the relationship will be nonexclusive. Thus, we
will have the right to purchase the glass panel output of a planned high-volume
manufacturing plant located in Taiwan, announced by Dupont and RiTdisplay
Technology Corporation. In addition, we will utilize other OLED glass panel
sources. Upon the request of Dupont Displays, we will also manufacture OLED
display modules for them at our display module assembly facilities in Beijing
and Manila. We have not worked with Dupont since the liquidation.

Write-Down of Assets Held for Sale

During the second quarter of 2001, we announced our strategic decision to
move our front-end manufacturing LCD line from Arizona to Asia. The front-end
LCD line was operated in Arizona through the third quarter of 2001 and was then
shut down. We now purchase all of our LCDs from third parties, although we
sometimes purchase partially completed LCDs and complete the back-end
operations on those LCDs in Manila. During the second quarter of 2002, we
signed a Cooperative Agreement with a Chinese company under which we agreed to
sell the equipment of our front-end LCD line and establish a supply agreement.
Under the terms of the Cooperative Agreement, and in exchange for our front-end
LCD equipment, we will receive $3.0 million in cash, favorable LCD glass pricing,
and flexible yet assured manufacturing capacity from this strategic partner.
In the second quarter of 2002, as a result of signing the Cooperative
Agreement, we realized a charge of $4.5 million for the loss on the equipment
to be sold to the Chinese company. This charge was reported as a separate line
item in operating expense. We received $2.1 million of the $3.0 million sales
price in 2002, all of which was recorded as a reduction in the carrying value
of the assets held for sale. The sale of the equipment is expected to be
completed in 2003.

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|(3) |  | Business Acquisitions:
|--- |  | ----------------------

In September 2002, we purchased the assets and ongoing business of AVT, a
privately held company that specializes in the design and integration of
complex, high-resolution display systems. AVT designs and provides customized
and ruggedized flat panel, touchscreen and rackmount systems for original
equipment manufacturers. The purchase price of the acquisition was $12.0
million, which we paid entirely in cash. The purchase agreement also calls for
a residual purchase payment of $2.0 million should the AVT division achieve
certain revenue and profit objectives for 2002 and 2003.

The purchase price was allocated as follows (in thousands):

|                              |                       |   |        |        | 
|----------------------------- | --------------------- | - | ------ | ------ | 
|Current assets                |                       | $ | 2,115  |       
|Property, plant and equipment |                       |   | 105    |       
|Customer list intangibles     |                       |   | 3,000  |       
|Goodwill                      |                       |   | 7,774  |       
|Other long-term assets        |                       |   | 40     |       
|Current liabilities           |                       |   | (1,045 | )     
|                              |                       |   |        |       
|                              | Net Acquisition price |   | $      | 11,989 | 
|                              |                       |   |        |       

In December 2002, we purchased the stock of ETMA Corporation, a privately
held electronic services manufacturer for OEM customers in the automotive,
computer/server, medical monitoring, and Internet security industries. ETMA
offers the manufacturing capabilities of six surface amount manufacturing
lines, including one dedicated to new product introduction and prototyping
activity. ETMA provides engineering support, automated printed circuit board
assembly, in-circuit and functional testing, systems integration and box build,
complete supply chain management, and turnkey packaging and fulfillment
services. The purchase price of the acquisition was $38.1 million, which we paid
entirely in cash.

The purchase price was allocated as follows (in thousands):

|                              |                       |   |        |        | 
|----------------------------- | --------------------- | - | ------ | ------ | 
|Current assets                |                       | $ | 17,389 |       
|Property, plant and equipment |                       |   | 1,454  |       
|Customer list intangibles     |                       |   | 2,000  |       
|Goodwill                      |                       |   | 27,127 |       
|Current liabilities           |                       |   | (9,842 | )     
|Long-term liabilities         |                       |   | (28    | )     
|                              |                       |   |        |       
|                              | Net Acquisition price |   | $      | 38,100 | 
|                              |                       |   |        |       

Total intangible assets from the acquisition of AVT and ETMA related to
customer lists of $5.0 million will be amortized over their weighted averaged
useful lives of approximately four years.

The results of operations of AVT and ETMA have been included in the
accompanying financial statements since their respective acquisition dates.
The acquisition of AVT was considered immaterial and pro forma results are
therefore not presented. Unaudited pro forma Consolidated Statements of Operations for
2001 and 2002, presented as if ETMA had been acquired at the beginning of each
year, are as follows (in thousands, except per share data):

|                                   |  |                          |         |      |  |   |         |  
|---------------------------------- |  | ------------------------ | ------- | ---- |  | - | ------- | -
|                                   |  | Years Ended December 31,
|                                   |  |                         
|                                   |  | 2001                     |         | 2002
|                                   |  |                          |         |     
|                                   |  | (unaudited)             
|Net sales                          |  | $                        | 172,533 |      |  | $ | 151,547 |  
|Net loss                           |  |                          | (21,044 | )    |  |   | (17,065 | )
|Loss per share (basic and diluted) |  |                          | (0.98   | )    |  |   | (0.80   | )

The pro forma includes a reduction in interest income related to the
presumption that the acquisition occurred as of January 1, 2001 and 2002 and
investments were therefore reduced by $38.1 million. ETMA incurred an unusual
item of $3.6 million in 2001 for the write-off of accounts receivable.

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|(4) |  | Debt:
|--- |  | -----

Borrowing under line of credit and term loan agreements were as follows at
(in thousands):

|                                                                                                                                                                                                                     |  |              |       |      |  |   |       | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----- | ---- |  | - | ----- | 
|                                                                                                                                                                                                                     |  | December 31,
|                                                                                                                                                                                                                     |  |             
|                                                                                                                                                                                                                     |  | 2001         |       | 2002
|                                                                                                                                                                                                                     |  |              |       |     
|$15.0 million revolving line of credit, interest due
monthly at the banks prime rate (4.25% at December
31, 2002) or at the LIBOR base rate (1.48% at
December 31, 2002) plus 1.5%, unpaid balance due July
1, 2003 |  | $            |      |      |  | $ |      | 
|$28.0 thousand vehicle financing for company vehicle
at our Redmond, Washington facility                                                                                                                             |  |              |      |      |  |   | 28    | 
|$2.706 million loan due Bank of China, interest due
quarterly at 5.85%, due April 30, 2003, secured by a
$3.0 million stand-by letter of credit issued under
the $15.0 million revolving line of credit              |  |              | 2,706 |      |  |   | 2,706 | 
|                                                                                                                                                                                                                     |  |              |       |      |  |   |       | 
|                                                                                                                                                                                                                     |  |              | 2,706 |      |  |   | 2,734 | 
|Less current portion                                                                                                                                                                                                 |  |              | 2,706 |      |  |   | 2,714 | 
|                                                                                                                                                                                                                     |  |              |       |      |  |   |       | 
|Long-term portion                                                                                                                                                                                                    |  | $            |      |      |  | $ | 20    | 
|                                                                                                                                                                                                                     |  |              |       |      |  |   |       | 

In January 2002, we renewed a $15.0 million unsecured revolving line of
credit with Comerica Bank, which was set to mature in January 2003. In May
2002, we extended the maturity date until July 2003. The revolving line of
credit contains restrictive covenants that include, among other things,
restrictions on the declaration or payment of dividends, the sale or transfer
of assets, and a minimum liquidity level. The company was compliant with the
covenants at December 31, 2002.

Interest
expense was $262,000, $101,000, and $186,000, respectively, for
2000, 2001, and 2002.



|(5) |  | Stockholders Equity:
|--- |  | ---------------------

In May 2000, we issued 2,150,000 shares of common stock at $55.00 per
share (the 2000 Offering). In June 2000, we issued 322,500 shares of common
stock at $55.00 per share to cover over-allotments pertaining to the 2000
Offering. Expenses for the 2000 Offering totaled $7,341,000, which were netted
against the total proceeds of the offering.

On December 7, 2000, our Board of Directors authorized a stock repurchase
program whereby our company, at the discretion of management, could buy back up
to $30.0 million of our common stock in the open market. During the year ended
December 31, 2000, we purchased 241,381 shares at a cost of $4,623,000. During
the year ended December 31, 2001, we purchased 149,197 shares at a cost of
$2,526,000. During the year ended December 31, 2002, we purchased 260,600
shares at a cost of $1,351,000.

During the second quarter of 2001, our Board of Directors adopted a
stockholder rights plan (the Rights Plan). Under the Rights Plan, we issued
a dividend of one Preferred Share Purchase Right (the Right) for each share
of common stock of our company held by stockholders of record as of the close
of business on May 14, 2001. Each Right entitles stockholders to buy one
one-thousandth (1/1000th) of a share of Series A Junior Participating Preferred
Stock of our company at an exercise price of $120.00 (subject to adjustment).
The Rights Plan was not adopted in response to any specific takeover threat.
The Rights Plan, however, was designed to assure that all of our stockholders
receive fair and equal treatment in the event of any proposed takeover of our
company, and to guard against coercive or unfair tactics to gain control of our
company without paying all stockholders a premium for that control.

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|(6) |  | Benefit Plans:
|--- |  | --------------

We have five stock option plans: the 1990 Stock Option Plan (1990 Plan),
the 1993 Stock Option Plan (1993 Plan), the 1994 Non-Employee Directors Stock
Option Plan (1994 Plan), the 1997 Stock Option Plan (1997 Plan), and 1998 Stock
Option Plan (1998 Plan).

1990 Stock Option Plan

Under the 1990 Plan, there were options issued but unexercised to purchase
85,622 shares as of December 31, 2002. The 1990 Plan expired on May 1, 2001,
at which time all unissued options expired.

The expiration date, maximum number of shares purchasable, and the other
provisions of the options granted under the 1990 Plan were established at the
time of grant. Options were granted for terms of up to ten years and became
exercisable in whole or in one or more installments at such times as were
determined by the Board of Directors upon grant of the options.

1993 Stock Option Plan

The 1993 Plan provides for the granting of options to purchase up to
770,909 shares of our common stock, the direct granting of common stock (stock
awards), the granting of stock appreciation rights (SARs), and the granting of
other cash awards (stock awards, SARs, and cash awards are collectively
referred to herein as Awards). Under the 1993 Plan, options and Awards may be
issued to key personnel and others providing valuable services to our company.
The options issued may be incentive stock options or nonqualified stock
options. If any option or SAR terminates or expires without having been
exercised in full, stock not issued under such option or SAR will again be
available for grant pursuant to the 1993 Plan. There were options outstanding
to acquire 336,722 shares of our companys common stock under the 1993 Plan at
December 31, 2002.

To the extent that granted options are incentive stock options, the terms
and conditions of those options must be consistent with the qualification
requirement set forth in the Internal Revenue Code of 1986 (the Code). The
expiration date, maximum number of shares purchasable, and the other provisions
of the options will be established at the time of grant. Options may be granted
for terms of up to ten years and become exercisable in whole or in one or more
installments at such time as may be determined by the plan administrator upon
grant of the options. The exercise prices of options are determined by the plan
administrator, but may not be less than 100% (110% if the option is an
incentive stock option granted to a stockholder who at the time the option is
granted owns stock representing more than 10% of the total combined voting
power of all classes of stock of our company) of the fair market value of the
common stock at the time of the grant. The 1993 Plan expires on February 24,
2003, at which time all unissued options will expire.

1994 Non-Employee Directors Stock Option Plan

The 1994 Plan provides for the automatic grant of stock options to
non-employee directors to purchase up to 100,000 shares of our common stock. On
April 26, 2001, the stockholders approved a proposal to amend our 1994
Automatic Stock Option Plan for Non-Employee Directors (the 1994 Plan). Now,
under the 1994 Plan, options to acquire 2,000 shares of common stock will be
automatically granted to each non-employee director at the meeting of our Board
of Directors held immediately after each annual meeting of stockholders, with
such options to vest in a series of 12 equal and successive monthly
installments commencing one month after the annual automatic grant date. In
addition, each non-employee director serving on our Board of Directors on the
date the 1994 Plan was approved by our stockholders received an automatic grant
of options to acquire 5,000 shares of common stock and each subsequent newly
elected non-employee member of our Board of Directors receives an automatic
grant of options to acquire 5,000 shares of common stock on the date of their
first appointment or election to our Board of Directors. Those options become
exercisable and vest in a series of three equal and successive annual
installments, with the first such installment becoming exercisable immediately
after the directors second successive election to our Board of Directors (the
First Vesting Date), the second installment becoming exercisable 10 months
after the First Vesting Date, and the third installment becoming exercisable 22
months after the First Vesting Date (provided that the director has not ceased
serving as a director prior to a vesting date). A non-employee member of our
Board

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##### Table of Contents



of Directors is not eligible to receive the 2,000 share automatic option grant
if that option grant date is within 30 days of such non-employee member
receiving the 5,000 share automatic option grant. The exercise price per share
of common stock subject to options granted under the 1994 Plan will be equal to
100% of the fair market value of our common stock on the date such options are
granted. There were outstanding options to acquire 40,260 shares of our common
stock under the 1994 Plan at December 31, 2002.

1997 Stock Option Plan

The 1997 Plan provides for the granting of nonqualified options to
purchase up to 2,100,000 shares of our common stock. Under the 1997 Plan,
options may be issued to key personnel and others providing valuable services
to our company. The options issued will be nonqualified stock options and
shall not be incentive stock options as defined in Section 422 of the Code. Any
option that expires or terminates without having been exercised in full will
again be available for grant pursuant to the 1997 Plan. There were options
outstanding to acquire 1,259,136 shares of our common stock under the 1997 Plan
at December 31, 2002.

The expiration date, maximum number of shares purchasable, and the other
provisions of the options will be established at the time of grant. Options may
be granted for terms of up to ten years and become exercisable in whole or in
one or more installments at such time as may be determined by the plan
administrator upon grant of the options. The exercise prices of the options are
determined by the plan administrator, but may not be less than 100% of the fair
market value of the common stock at the time of the grant. The 1997 Plan will
remain in force until May 12, 2007.

1998 Stock Option Plan

The 1998 Plan provides for the granting of incentive stock options and/or
nonqualified options to purchase up to 1,600,000 shares of our common stock.
Under the 1998 Plan, options may be issued to key personnel and others
providing valuable services to our company. The options issued will be
incentive stock options or nonqualified stock options as defined in Section 422
of the Code. Any option that expires or terminates without having been
exercised in full will again be available for grant pursuant to the 1998 Plan.
There were options outstanding to acquire 1,168,988 shares of our common stock
under the 1998 Plan at December 31, 2002.

The expiration date, maximum number of shares purchasable, and the other
provisions of the options will be established at the time of grant. Options may
be granted for terms of up to ten years and become exercisable in whole or in
one or more installments at such time as may be determined by the plan
administrator upon grant of the options. The exercise prices of the options are
determined by the plan administrator, but may not be less than 100% of the fair
market value of the common stock at the time of the grant (110% if the option
is an incentive stock option granted to a stockholder who at the time the
option is granted owns stock representing more than 10% of the total combined
voting power of all classes of stock of our company). The 1998 Plan will remain
in force until January 28, 2008.

Tax benefits from option exercises are credited to additional paid-in
capital.

The following table and narrative summarizes the status of our five stock
option plans at December 31, 2000, 2001, and 2002 and changes during the years
then ended:

|                                               |  |         |           |       |  |          |       |       |  |         |           |          |  |   |       |  |  |          |           |   |  |   |       | 
|---------------------------------------------- |  | ------- | --------- | ----- |  | -------- | ----- | ----- |  | ------- | --------- | -------- |  | - | ----- |  |  | -------- | --------- | - |  | - | ----- | 
|                                               |  | 2000    |           | 2001  |  | 2002    
|                                               |  |         |           |       |  |         
|                                               |  |         |           |       |  | Weighted |       |       |  |         |           | Weighted |  |   |       |  |  | Weighted
|                                               |  |         |           |       |  | Average  |       |       |  |         |           | Average  |  |   |       |  |  | Average 
|                                               |  |         |           |       |  | Exercise |       |       |  |         |           | Exercise |  |   |       |  |  | Exercise
|                                               |  | Options |           | Price |  | Options  |       | Price |  | Options |           | Price   
|                                               |  |         |           |       |  |          |       |       |  |         |           |         
|Outstanding at beginning
of year               |  |         | 1,737,397 |       |  | $        | 7.76  |       |  |         | 1,974,668 |          |  | $ | 14.75 |  |  |          | 2,086,969 |   |  | $ | 14.97 | 
|Granted                                        |  |         | 528,873   |       |  |          | 33.95 |       |  |         | 535,295   |          |  |   | 19.44 |  |  |          | 1,153,699 |   |  |   | 9.21  | 
|Exercised                                      |  |         | (228,063  | )     |  |          | 7.46  |       |  |         | (235,665  | )        |  |   | 6.55  |  |  |          | (39,183   | ) |  |   | 5.35  | 
|Expired or canceled                            |  |         | (63,539   | )     |  |          | 9.58  |       |  |         | (187,329  | )        |  |   | 35.97 |  |  |          | (310,757  | ) |  |   | 16.94 | 
|                                               |  |         |           |       |  |          |       |       |  |         |           |          |  |   |       |  |  |          |           |   |  |   |       | 
|Outstanding at end of year                     |  |         | 1,974,668 |       |  |          | 14.75 |       |  |         | 2,086,969 |          |  |   | 14.97 |  |  |          | 2,890,728 |   |  |   | 12.59 | 
|                                               |  |         |           |       |  |          |       |       |  |         |           |          |  |   |       |  |  |          |           |   |  |   |       | 
|Exercisable at end of year                     |  |         | 485,050   |       |  | $        | 7.12  |       |  |         | 617,906   |          |  | $ | 9.81  |  |  |          | 1,042,169 |   |  | $ | 11.48 | 
|                                               |  |         |           |       |  |          |       |       |  |         |           |          |  |   |       |  |  |          |           |   |  |   |       | 
|Weighted average fair value of
options granted |  |         |           |       |  | $        | 27.24 |       |  |         |           |          |  | $ | 16.13 |  |  |          |           |   |  | $ | 7.29  | 
|                                               |  |         |           |       |  |          |       |       |  |         |           |          |  |   |       |  |  |          |           |   |  |   |       | 

F-21



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##### Table of Contents



The following table summarizes information about stock options outstanding
at December 31, 2002:

|                    |  |                     |           |             |  |          |     |              |  |          |       |  |  |  |           |  |  |   |       | 
|------------------- |  | ------------------- | --------- | ----------- |  | -------- | --- | ------------ |  | -------- | ----- |  |  |  | --------- |  |  | - | ----- | 
|Options Outstanding |  | Options Exercisable
|                    |  |                    
|                    |  | Number              |           | Weighted    |  |          |     |              |  | Number   |       |  |  | 
|                    |  | Outstanding         |           | Average     |  | Weighted |     | Exercisable  |  | Weighted
|Range of            |  | at                  |           | Remaining   |  | Average  |     | at           |  | Average 
|Exercise            |  | December 31,        |           | Contractual |  | Exercise |     | December 31, |  | Exercise
|Prices              |  | 2002                |           | Life        |  | Price    |     | 2002         |  | Price   
|                    |  |                     |           |             |  |          |     |              |  |         
|$0.32 - $7.46       |  |                     | 992,565   |             |  |          | 7.4 |              |  | $        | 6.05  |  |  |  | 393,008   |  |  | $ | 5.76  | 
|7.47 - 14.92        |  |                     | 1,159,893 |             |  |          | 7.1 |              |  |          | 10.75 |  |  |  | 442,712   |  |  |   | 9.40  | 
|14.93 - 74.63       |  |                     | 738,270   |             |  |          | 7.3 |              |  |          | 24.28 |  |  |  | 206,449   |  |  |   | 26.86 | 
|                    |  |                     |           |             |  |          |     |              |  |          |       |  |  |  |           |  |  |   |       | 
|                    |  |                     | 2,890,728 |             |  |          | 7.3 |              |  | $        | 12.59 |  |  |  | 1,042,169 |  |  | $ | 11.48 | 
|                    |  |                     |           |             |  |          |     |              |  |          |       |  |  |  |           |  |  |   |       | 

401(k) Profit Sharing Plan

We have adopted a profit sharing plan (401(k) Plan) pursuant to Section
401(k) of the Code. The 401(k) Plan covers substantially all full-time
employees who meet the eligibility requirements and provides for a
discretionary profit sharing contribution by us and an employee elective
contribution with a discretionary matching provision by our company. We
expensed discretionary contributions pursuant to the 401(k) Plan in the amount
of $207,000, $262,000, and $200,000 for the years ended December 31, 2000,
2001, and 2002, respectively.

Pension Plan

On June 1, 2001, Pacific adopted a defined benefit pension plan (the
Pension Plan) for its employees. The Pension Plan covers most regular Pacific
employees. The Pension Plan benefits were retroactive to an employees date of
hire, resulting in a pension benefit obligation as of January 1, 2001 of
$249,000. The pension benefit obligation at December 31, 2001 and 2002 was
$349,000 and $210,000, respectively.



|(7)                                                                                                                                                                                                         |  | Income Taxes:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------
|                                                                                                                                                                                                           
|The following table presents the U.S. and international components of income
(loss) from continuing operations before income taxes for the years ended
December 31 consist of the following (in thousands):
|                                                                                                                                                                                                           
|Operations Before Income
Taxes                                                                                                                                                                             

|                    |  |              |        |      |  |      |         |   |  |   |         |  
|------------------- |  | ------------ | ------ | ---- |  | ---- | ------- | - |  | - | ------- | -
|                    |  | December 31,
|                    |  |             
|                    |  | 2000         |        | 2001 |  | 2002
|                    |  |              |        |      |  |     
|United States       |  | $            | 12,895 |      |  | $    | (29,752 | ) |  | $ | (31,089 | )
|International       |  |              | 7,453  |      |  |      | 3,243   |   |  |   | 3,465   |  
|                    |  |              |        |      |  |      |         |   |  |   |         |  
|Total Pretax Income |  | $            | 20,348 |      |  | $    | (26,509 | ) |  | $ | (27,624 | )
|                    |  |              |        |      |  |      |         |   |  |   |         |  



| |  | The provision (benefit) for income taxes for the years ended December 31
consists of the following (in thousands):
| |  | ------------------------------------------------------------------------------------------------------------------

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##### Table of Contents



|                                                          |                                                         |                                           |       |       |       |      |        |        |        |   |        |        |         |  
|--------------------------------------------------------- | ------------------------------------------------------- | ----------------------------------------- | ----- | ----- | ----- | ---- | ------ | ------ | ------ | - | ------ | ------ | ------- | -
|                                                          |                                                         |                                           |       | 2000  |       | 2001 |        | 2002  
|                                                          |                                                         |                                           |       |       |       |      |        |       
|Current provision (benefit), net of tax credits utilized: |                                                         |                                           |       |       |       |      |        |        |        |   |        |       
|                                                          | Federal, net of tax benefit from stock option
exercises |                                           | $     | 4,641 |       |      | $      | (5,555 | )      |   | $      | (2,163 | )      
|                                                          | States                                                  |                                           |       | 45    |       |      |        |       |        |   |        |       |        
|                                                          | Foreign                                                 |                                           |       | 780   |       |      |        | 797    |        |   |        | 486    |        
|                                                          |                                                         |                                           |       |       |       |      |        |        |        |   |        |       
|                                                          |                                                         |                                           | 5,466 |       |       |      | (4,758 | )      |        |   | (1,677 | )     
|                                                          | Deferred benefit                                        |                                           |       | (626  | )     |      |        | (4,575 | )      |   |        | (9,021 | )      
|                                                          | Tax benefit from stock option exercises                 |                                           |       | 674   |       |      |        | 588    |        |   |        | 45     |        
|                                                          |                                                         |                                           |       |       |       |      |        |        |        |   |        |       
|                                                          |                                                         | Provision
for (benefit from) income taxes |       | $     | 5,514 |      |        | $      | (8,745 | ) |        | $      | (10,653 | )
|                                                          |                                                         |                                           |       |       |       |      |        |        |        |   |        |       

In accordance with SFAS No. 109, tax credits of approximately $1,244,000,
$0, and $0 were utilized in 2000, 2001, and 2002, respectively, and are
included as a reduction of the current provision for income taxes in the
consolidated statements of income.

The components of deferred taxes at December 31 are as follows (in
thousands):

|                                                 |                                                           |   |       |        |      |   |       |        |  
|------------------------------------------------ | --------------------------------------------------------- | - | ----- | ------ | ---- | - | ----- | ------ | -
|                                                 |                                                           |   | 2001  |        | 2002
|                                                 |                                                           |   |       |        |     
|Net short-term deferred tax assets:              |                                                           |   |       |        |      |   |       |       
|                                                 | Uniform capitalization                                    |   | $     | 1,224  |      |   | $     | 1,653  |  
|                                                 | Accrued liabilities and reserves not currently deductible |   |       | 2,405  |      |   |       | 1,641  |  
|                                                 | Allowance for doubtful accounts                           |   |       | 76     |      |   |       | 56     |  
|                                                 | Other                                                     |   |       | 225    |      |   |       | 211    |  
|                                                 |                                                           |   |       |        |      |   |       |       
|                                                 |                                                           | $ | 3,930 |        |      | $ | 3,561 |       
|                                                 |                                                           |   |       |        |      |   |       |       
|Net long-term deferred tax (liabilities)/assets: |                                                           |   |       |        |      |   |       |       
|                                                 | Accelerated tax depreciation                              |   | $     | (4,556 | )    |   | $     | (1,944 | )
|                                                 | Net operating loss and tax credit carryforward            |   |       | 5,153  |      |   |       | 12,745 |  
|                                                 | Capital loss carryforward                                 |   |       | 1,299  |      |   |       | 1,288  |  
|                                                 | Valuation allowance against capital loss carryforward     |   |       | (1,299 | )    |   |       | (1,288 | )
|                                                 | Valuation allowance against foreign tax credits           |   |       |       |      |   |       | (776   | )
|                                                 | Investments in foreign affiliates                         |   |       | (378   | )    |   |       | (383   | )
|                                                 |                                                           |   |       |        |      |   |       |       
|                                                 |                                                           | $ | 219   |        |      | $ | 9,642 |       
|                                                 |                                                           |   |       |        |      |   |       |       

We currently have $13.2 million of net deferred tax assets resulting
primarily from net operating loss and tax credit carryforwards. SFAS No. 109
requires that a valuation allowance be established when it is more likely than
not that all or a portion of a deferred tax asset will not be realized.
Changes in valuation allowances from period to period are included in our tax
provision in the period of change. In determining whether a valuation
allowance is required, we take into account all evidence with regard to the
utilization of a deferred tax asset including our past earnings history,
expected future earnings, the character and jurisdiction of such earnings,
unsettled circumstances that, if unfavorably resolved, would adversely affect
utilization of a deferred tax asset, carryback and carryforward periods, and
tax strategies that could potentially enhance the likelihood of realization of
a deferred tax asset. We believe that the net deferred tax assets of $13.2
million will be realized based primarily on our projected future earnings and
scheduling of our deferred tax liabilities. However, the amount of the
deferred tax assets actually realized could differ if we have little or no
future earnings. The valuation allowance increased by $1,299,000 and $765,000
in 2001 and 2002.

At December 31, 2002, we have a valuation allowance of $2.1 million for
deferred tax assets related to a capital loss carryforward and certain foreign
tax credit.

Our capital loss carryforward expires in 2006. We have $29.5 million of
federal net operating loss carryforwards that begin to expire in 2022. We have
other general business credit carryforwards that expire 2017.

F-23



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##### Table of Contents



A reconciliation of the U.S. federal statutory rate to our effective tax
rate is as follows:

|                                          |  |      |    |      |  |      |     |    |  |  |     |   
|----------------------------------------- |  | ---- | -- | ---- |  | ---- | --- | -- |  |  | --- | --
|                                          |  | 2000 |    | 2001 |  | 2002
|                                          |  |      |    |      |  |     
|Statutory federal rate                    |  |      | 35 | %    |  |      | (34 | %) |  |  | (34 | )%
|Effect of state taxes                     |  |      | 2  |      |  |      |    |    |  |  |    |   
|Foreign earnings taxed at different rates |  |      | (5 | )    |  |      | (3  | )  |  |  | (5  | ) 
|Other, net                                |  |      |   |      |  |      | 1   |    |  |  | (1  | ) 
|Valuation Allowance                       |  |      |   |      |  |      | 5   |    |  |  | 3   |   
|Credits for research and development      |  |      | (5 | )    |  |      | (2  | )  |  |  | (2  | ) 
|                                          |  |      |    |      |  |      |     |    |  |  |     |   
|                                          |  |      | 27 | %    |  |      | (33 | )% |  |  | (39 | )%
|                                          |  |      |    |      |  |      |     |    |  |  |     |   

A deferred U.S. tax liability has not been provided on the undistributed
earnings of certain foreign subsidiaries because it is our intent to
permanently reinvest such earnings. Undistributed earnings of foreign
subsidiaries, which have been, or are intended to be, permanently invested in
accordance with APB No. 23, Accounting for Income Taxes  Special Areas,
aggregated approximately $7.2 million at December 31, 2002.

Although losses are expected to continue in the near term through the
projected spin-off date, as of December 31, 2002, in accordance with SFAS No.
109, no valuation allowance has been recorded related to our net operating loss
and tax credit carryforward, as we believe that the full realization of these
deferred tax assets is more likely than not.



|(8) |  | Commitments and Contingencies:
|--- |  | ------------------------------

Rent and Lease

In April 2001, Pacific began its lease of a build-to-suit factory in
Manila. The term of the lease is 125 months. We employ our own employees at
this new factory. Until April 2002, our back-end LCD processing operations
were conducted by a third party subcontractor in Manila. Since that date, the
Manila back-end LCD processing is performed by our own employees.

We own and occupy an approximately 97,000 square foot facility in Tempe,
Arizona, which houses our U.S.-based manufacturing operations and our research,
development, engineering, design, and corporate functions. We entered into a
ground lease for this facility that extends through March 31, 2069, subject to
renewal and purchase options as well as early termination provisions. The
annual lease payments on the related land are approximately $100,000, subject
to certain escalation provisions.

Our future lease commitments under the non-cancelable operating leases as
of December 31, 2002 are as follows (in thousands):

|           |  |   |        | 
|---------- |  | - | ------ | 
|2003       |  | $ | 3,646  | 
|2004       |  |   | 3,060  | 
|2005       |  |   | 2,581  | 
|2006       |  |   | 1,984  | 
|2007       |  |   | 1,550  | 
|Thereafter |  |   | 10,138 | 
|           |  |   |        | 
|           |  | $ | 22,959 | 
|           |  |   |        | 

Rent expense was approximately $553,000, $712,000, and $1,783,000 for the
years ended December 31, 2000, 2001, and 2002, respectively.

Guarantee

In
February 2002, we guaranteed up to $450,000 of the debt of a
start-up company, VoiceView Technology, Inc., a private company developing
microdisplay products. As of December 31, 2002, the outstanding
balance on the debt is $428,000. This loan guarantee had a five year term and matures in
January 2007. At this time, no liability has been recognized by us. We will
be required to pay this guarantee to the lender if the start-up company
defaults on its debt obligations.

F-24



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##### Table of Contents



Legal Proceedings

In 1991, we received a notice of potential liability at the
Barkhamsted-New Hartford Landfill Site (the Landfill) in Barkhamsted,
Connecticut from the United States Environmental Protection Agency (EPA).
Fifty-seven other entities received similar letters. In January 1992, we
received a 104(e) questionnaire from the EPA which was completed and submitted
during 1992. We received verbal notification that we had no further liability
in the matter. According to the EPA, groundwater contamination at the site,
which includes volatile and semi-volatile organic compounds and low
concentrations of metals, constitutes a low-level threat. As a result of
previous actions at the site, groundwater is the only medium requiring
additional cleanup. All source material and principal threats have been
addressed through the landfill capping and related activity completed in 1999.
On February 28, 2002, we received notification from the EPA that the EPA
believes we were an involved party and indicated that the EPA was seeking to
negotiate an agreement with the involved parties to fund the EPAs chosen
remedy of monitored natural attenuation of the groundwater. We have reached a
settlement on that matter for $65,000 and have no further liability with
respect to this issue. This charge was recorded in sales, general and
administrative expenses in 2002.

We are also involved in certain administrative proceedings arising in the
normal course of business. In our opinion, the ultimate settlement of these
administrative proceedings will not materially impact our financial position or
results of operations.

Derivative Instruments

We have certain receivables denominated in Chinese renminbi. To eliminate
our exposure to changes in the U.S. dollar/Chinese renminbi exchange rate, we
have entered into forward contracts to protect our future cash flows. Our
forward contracts generally range from one to six months in original maturity.

In accordance with SFAS No. 133, we designate such forward contracts as
cash flow hedges. We account for changes in the fair value of our forward
contracts, based on changes in the forward exchange rate, with all such changes
in fair value reported in other comprehensive income. Amounts in other
comprehensive income are reclassified into earnings upon settlement of the
forward contract at an amount that will offset the related transaction gain or
loss arising from the re-measurement and adjust earnings for the cost of the
forward contracts. During 2002, there were no significant gains or losses
recognized in earnings for hedge ineffectiveness and we did not discontinue any
hedges because it was probable that the original forecasted transaction would
not occur. As of December 31, 2002, there were no contracts outstanding.



|(9) |  | Segment Information:
|--- |  | --------------------

We monitor and evaluate the financial performance of our operations by our
two product lines (operating segments): ISD and Microdisplay. In the ISD
segment, we focus on display products and our electronic manufacturing
services. We specialize in custom and standard display modules utilizing
various display technologies, including liquid crystal displays, or LCDs,
organic light emitting displays, or OLEDs, and cathode ray tubes, or CRTs. Our
display modules are of varying sizes and have varying levels of integration.
At a minimum, each display module includes a display, a custom driver, and a
flexible connector. We also provide ruggedized and customized monitors. We
also provide value-added services, which increase our competitiveness, by
assembling additional components onto the module based upon the specific needs
of the customer. These additional components may include such items as
keypads, microphones, speakers, light guides, and optics. Late in 2002, we
expanded the value-added manufacturing services we provide in the ISD segment
through our acquisition of ETMA Corporation. As a result of that acquisition,
we now provide printed circuit board assembly, or PCBA, and box build
capabilities to customers, even in products that do not need displays.

In our second business segment, referred to as the Microdisplay segment,
we offer a range of LCoSproduct solutions with different levels of integration
from individual images to optical light engines. The focused markets for our
LCoSmicrodisplay products are large screen television sets, front projectors,
and near-to-eye or personal display system applications.

The accounting policies of the operating segments are the same as those
described in Note 2, Summary of Significant Accounting Policies. Non-specific
operating segment expenses were allocated based upon estimated

F-25



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##### Table of Contents



usage. Interest income was assigned to the ISD operating segment for 2000
and 2001 and was split between the ISD and Microdisplay segments for 2002. The
worldwide average tax rate was used for all segments. The following includes
financial information (in thousands, except share data) for our two operating
segments:

|                                          |  |     |         |              |  |       |        |   |  |   |         | 
|----------------------------------------- |  | --- | ------- | ------------ |  | ----- | ------ | - |  | - | ------- | 
|                                          |  | ISD |         | Microdisplay |  | Total
|                                          |  |     |         |              |  |      
|December 31, 2000                         |  |     |         |              |  |       |        |   |  |   |         | 
|Net sales                                 |  | $   | 159,369 |              |  | $     | 1,315  |   |  | $ | 160,684 | 
|Other income                              |  |     | 7,184   |              |  |       |       |   |  |   | 7,184   | 
|Provision for (benefit from)
income taxes |  |     | 7,770   |              |  |       | (2,256 | ) |  |   | 5,514   | 
|Net income (loss)                         |  |     | 20,904  |              |  |       | (6,070 | ) |  |   | 14,834  | 
|Goodwill                                  |  |     |        |              |  |       |       |   |  |   |        | 

|                          |  |     |         |              |  |       |         |   |  |   |         |  
|------------------------- |  | --- | ------- | ------------ |  | ----- | ------- | - |  | - | ------- | -
|                          |  | ISD |         | Microdisplay |  | Total
|                          |  |     |         |              |  |      
|December 31, 2001         |  |     |         |              |  |       |         |   |  |   |         |  
|Net sales                 |  | $   | 117,234 |              |  | $     | 1,902   |   |  | $ | 119,136 |  
|Other income (expenses)   |  |     | 7,270   |              |  |       | (3,820  | ) |  |   | 3,450   |  
|Benefit from income taxes |  |     | (1,832  | )            |  |       | (6,913  | ) |  |   | (8,745  | )
|Net loss                  |  |     | (3,732  | )            |  |       | (14,032 | ) |  |   | (17,764 | )
|Goodwill                  |  |     |        |              |  |       |        |   |  |   |        |  

|                                             |  |     |        |              |  |       |         |   |  |   |         |  
|-------------------------------------------- |  | --- | ------ | ------------ |  | ----- | ------- | - |  | - | ------- | -
|                                             |  | ISD |        | Microdisplay |  | Total
|                                             |  |     |        |              |  |      
|December 31, 2002                            |  |     |        |              |  |       |         |   |  |   |         |  
|Net sales                                    |  | $   | 86,587 |              |  | $     | 1,439   |   |  | $ | 88,026  |  
|Write-off of assets held for sale            |  |     | 4,545  |              |  |       |        |   |  |   | 4,545   |  
|Other income                                 |  |     | 1,745  |              |  |       | 1,747   |   |  |   | 3,492   |  
|Benefit from income taxes income
taxes taxes |  |     | (2,415 | )            |  |       | (8,238  | ) |  |   | (10,653 | )
|Net loss                                     |  |     | (3,867 | )            |  |       | (13,104 | ) |  |   | (16,971 | )
|Goodwill                                     |  |     | 34,091 |              |  |       |        |   |  |   | 34,901  |  

Property, Plant and Equipment data for the ISD and Microdisplay segments
is not presented as it is not readily available and is not used by the key
decision makers for managing the business.

We also track net sales and long-lived assets data by geographic location.
Net sales by geographic area are determined based upon the location of the end
customer while long-lived assets are based upon the physical location of our
companys assets. Long-lived assets include property, plant and equipment,
and intangibles for each geographic location. The following includes financial
information (in thousands) for our geographic areas:

F-26



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##### Table of Contents



|                         |  |         |        |       |  |         |        |       |  |   |        |  |  |   |         | 
|------------------------ |  | ------- | ------ | ----- |  | ------- | ------ | ----- |  | - | ------ |  |  | - | ------- | 
|                         |  | North   |        |       |  |         |        | Other |  |   |        | 
|                         |  | America |        | China |  | Foreign |        | Total
|                         |  |         |        |       |  |         |        |      
|December 31, 2000        |  |         |        |       |  |         |        |       |  |   |        |  |  |   |         | 
|Net Sales                |  | $       | 25,414 |       |  | $       | 61,835 |       |  | $ | 73,435 |  |  | $ | 160,684 | 
|Long-lived assets, gross |  |         | 40,869 |       |  |         | 11,453 |       |  |   | 17,866 |  |  |   | 70,188  | 
|Goodwill                 |  |         |       |       |  |         |       |       |  |   |       |  |  |   |        | 
|December 31, 2001        |  |         |        |       |  |         |        |       |  |   |        |  |  |   |         | 
|Net Sales                |  | $       | 20,026 |       |  | $       | 48,310 |       |  | $ | 50,800 |  |  | $ | 119,136 | 
|Long-lived assets, gross |  |         | 45,707 |       |  |         | 12,739 |       |  |   | 18,393 |  |  |   | 76,839  | 
|Goodwill                 |  |         |       |       |  |         |       |       |  |   |       |  |  |   |        | 
|December 31, 2002        |  |         |        |       |  |         |        |       |  |   |        |  |  |   |         | 
|Net Sales                |  | $       | 13,099 |       |  | $       | 34,984 |       |  | $ | 39,943 |  |  | $ | 88,026  | 
|Long-lived assets, gross |  |         | 50,043 |       |  |         | 13,167 |       |  |   | 18,699 |  |  |   | 81,909  | 
|Goodwill                 |  |         | 34,901 |       |  |         |       |       |  |   |       |  |  |   | 34,901  | 



|(10) |  | Selected Quarterly Financial Data (Unaudited)
|---- |  | ---------------------------------------------

The following table summarizes the unaudited consolidated quarterly
results of operations as reported for 2001 and 2002 (in thousands, except per
share amounts):

|                                  |         |   |                |      |        |   |         |       |        |   |        |       |        |   |        |       |        |   |        |       |   |   |        |       |   |   |        |       |   |   |        |       |  
|--------------------------------- | ------- | - | -------------- | ---- | ------ | - | ------- | ----- | ------ | - | ------ | ----- | ------ | - | ------ | ----- | ------ | - | ------ | ----- | - | - | ------ | ----- | - | - | ------ | ----- | - | - | ------ | ----- | -
|                                  |         |   | Quarters Ended
|                                  |         |   |               
|                                  |         |   | 2001           |      | 2002  
|                                  |         |   |                |      |       
|                                  |         |   | Mar 31         |      | Jun 30 |   | Sep 30  |       | Dec 31 |   | Mar 31 |       | Jun 30 |   | Sep 30 |       | Dec 31
|                                  |         |   |                |      |        |   |         |       |        |   |        |       |        |   |        |       |       
|Net sales                         |         | $ | 35,616         |      |        | $ | 25,013  |       |        | $ | 26,594 |       |        | $ | 31,913 |       |        | $ | 23,110 |       |   | $ | 24,087 |       |   | $ | 18,584 |       |   | $ | 22,245 |      
|Gross profit (loss)               |         |   | 4,373          |      |        |   | (7,147  | )     |        |   | (859   | )     |        |   | 1,255  |       |        |   | 208    |       |   |   | 603    |       |   |   | 535    |       |   |   | 1,547  |      
|Net income (loss)                 |         |   | 242            |      |        |   | (11,348 | )     |        |   | (3,996 | )     |        |   | (2,662 | )     |        |   | (4,310 | )     |   |   | (6,640 | )     |   |   | (3,380 | )     |   |   | (2,641 | )    
|Earnings (loss) per
common share: |         |   |                |      |        |   |         |       |        |   |        |       |        |   |        |       |        |   |        |       |   |   |        |       |   |   |        |       |   |   |        |      
|                                  | Basic   |   | $              | 0.01 |        |   | $       | (0.53 | )      |   | $      | (0.19 | )      |   | $      | (0.12 | )      |   | $      | (0.20 | ) |   | $      | (0.31 | ) |   | $      | (0.16 | ) |   | $      | (0.12 | )
|                                  | Diluted |   | $              | 0.01 |        |   | $       | (0.53 | )      |   | $      | (0.19 | )      |   | $      | (0.12 | )      |   | $      | (0.20 | ) |   | $      | (0.31 | ) |   | $      | (0.16 | ) |   | $      | (0.12 | )

The quarter ended June 30, 2001 included the $3.8 million write-off of our
investment in a start-up company. The quarter ended June 30, 2002 included the
$4.5 million charge related to the LCD line sale.



|(11) |  | Subsequent Events
|---- |  | -----------------

In January 2003, we signed licensing and manufacturing agreements with
Data International Co., Ltd. of Taiwan. The cost of the license is anticipated
to be $4.0 million of which $1.0 million was paid upon signing and the other
$3.0 million is due over the next two years. The unpaid $3.0 million is
subject to reduction if certain revenue and margin targets are not met.

We recently announced that our board of directors has approved a decision
to spin-off our microdisplay division into a newly created and separately
traded public company to be known as Three-Five Microdisplay, Inc. or TFMD. We
expect that the proposed spin-off will allow each company to focus attention
and financial resources on its own target markets and also provide each
independent company with greater capital financing flexibility to support
growth opportunities in the future. We also expect that this separation will
be beneficial to both companies by creating better opportunities for strategic
alliances and partnerships with key customers, suppliers, and possible
potential competitors. Under the proposed spin-off transaction, we would
transfer our entire LCoSmicrodisplay business, including all related
manufacturing and business assets, personnel, and intellectual property, to
TFMD, a newly created subsidiary. We then expect to capitalize TFMD with
approximately $15 to $25 million in cash and distribute 100% of TFMDs common
stock to our stockholders of record pro rata as a dividend. We have filed a
ruling request with the Internal Revenue Service to qualify the spin-off of
TFMD as a nontaxable transaction. In addition, we expect to file a Form 10
with the Securities and Exchange Commission within the next 60 days
providing detailed information regarding the proposed transaction. No
stockholder vote will be required to affect the spin-off and no consideration
will be required to be paid by our stockholders in order to receive the stock
of TFMD.

F-27



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##### Table of Contents



THREE-FIVE SYSTEMS, INC. AND SUBSIDIARIES

SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the Years Ended December 31, 2000, 2001 and 2002

|                                  |                       |  |                |     |            |  |              |      |            |  |               |   |            |  |   |     |   |  |   |     | 
|--------------------------------- | --------------------- |  | -------------- | --- | ---------- |  | ------------ | ---- | ---------- |  | ------------- | - | ---------- |  | - | --- | - |  | - | --- | 
|                                  |                       |  |                |     |            |  | Increases    |      |            |  |               |   |            |  |   |     |   |  |  
|                                  |                       |  |                |     |            |  | (Reductions) |      |            |  |               |   |            |  |   |     |   |  |  
|                                  |                       |  | Balance at     |     | Charged to |  | Charged to   |      |            |  |               |   |            |  |  
|                                  |                       |  | beginning of   |     | Costs and  |  | Other        |      |            |  |               |   | Balance at
|                                  |                       |  | Period         |     | Expenses   |  | Accounts     |      | Write-offs |  | End of Period
|                                  |                       |  |                |     |            |  |              |      |            |  |              
|                                  |                       |  | (in thousands)
|Allowance for doubtful accounts : |                       |  |                |     |            |  |              |      |            |  |               |   |            |  |   |     |   |  |   |    
|                                  | Year ended 12/31/2000 |  | $              | 750 |            |  | $            | (316 | )          |  | $             |  |            |  | $ | 5   |   |  | $ | 439 | 
|                                  | Year ended 12/31/2001 |  |                | 439 |            |  |              | (180 | )          |  |               |  |            |  |   |    |   |  |   | 259 | 
|                                  | Year ended 12/31/2002 |  |                | 259 |            |  |              | 282  |            |  |               |  |            |  |   | (95 | ) |  |   | 446 | 

S-1



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##### Table of Contents






Index to Exhibits

|               |  |                                                                                                                                                                                                                     
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Exhibits                                                                                                                                                                                                            
|               |  |                                                                                                                                                                                                                     
|               |  |                                                                                                                                                                                                                     
|2              |  | Amended and Restated Agreement and Plan of Reorganization(1)                                                                                                                                                        
|               |  |                                                                                                                                                                                                                     
|3(i)(a)        |  | Amended and Restated Certificate of Incorporation of the Company(2)                                                                                                                                                 
|               |  |                                                                                                                                                                                                                     
|3(i)(b)        |  | Certificate of Amendment of Restated Certificate of Incorporation(3)                                                                                                                                                
|               |  |                                                                                                                                                                                                                     
|3(i)(c)        |  | Certificate of Designation of Series A Junior Participating Preferred Stock(4)                                                                                                                                      
|               |  |                                                                                                                                                                                                                     
|3(ii)          |  | Amended and Restated Bylaws of the Company(5)                                                                                                                                                                       
|               |  |                                                                                                                                                                                                                     
|4.1            |  | Form of Certificate of Common Stock*                                                                                                                                                                                
|               |  |                                                                                                                                                                                                                     
|4.2            |  | Rights Agreement, dated as of April 26, 2001, between Three-Five Systems, Inc. and
Bank of New York, as Rights Agent(6)                                                                                             
|               |  |                                                                                                                                                                                                                     
|10.1           |  | Line of Credit Agreement between Three-Five Systems Limited and Barclays Bank,
PLC(7)                                                                                                                               
|               |  |                                                                                                                                                                                                                     
|10.2           |  | Ground Sublease dated April 1, 1994, between Papago Park Center, Inc. and
Three-Five Systems, Inc.(8)                                                                                                               
|               |  |                                                                                                                                                                                                                     
|10.3           |  | Amended and Restated 1990 Incentive Stock Option Plan (as Amended and Restated
through March 7, 2003)*                                                                                                              
|               |  |                                                                                                                                                                                                                     
|10.4           |  | Amended and Restated 1993 Stock Option Plan (as Amended and Restated through March
7, 2003)*                                                                                                                        
|               |  |                                                                                                                                                                                                                     
|10.5           |  | Amended and Restated 1994 Stock Option Plan for Non-Employee Directors (as Amended
and Restated through February 12, 2001)(9)                                                                                       
|               |  |                                                                                                                                                                                                                     
|10.6           |  | Amended and Restated 1997 Employee Stock Option Plan (as Amended and Restated
through November 27, 2002)*                                                                                                           
|               |  |                                                                                                                                                                                                                     
|10.7           |  | Form of Notice and Acceptance of Stock Option Grant for Amended and Restated 1997
Employee Stock Option Plan(10)                                                                                                    
|               |  |                                                                                                                                                                                                                     
|10.8           |  | Amended and Restated 1998 Stock Option Plan* (as Amended and Restated through
February 8, 2002)                                                                                                                     
|               |  |                                                                                                                                                                                                                     
|10.9           |  | Amended and Restated Directors Stock Plan (amended as of January 27, 2000)(11)                                                                                                                                     
|               |  |                                                                                                                                                                                                                     
|10.10          |  | 401(k) Profit Sharing Plan(12)                                                                                                                                                                                      
|               |  |                                                                                                                                                                                                                     
|10.11          |  | Credit Agreement dated January 21, 2000, by and among Three-Five Systems, Inc., its
subsidiaries, the Banks named therein, and Imperial Bank Arizona, as Agent and as
Issuing Bank(13)                              
|               |  |                                                                                                                                                                                                                     
|10.12          |  | Modification Agreement dated February 1, 2001, by and among Three-Five Systems,
Inc., its subsidiaries, the Banks named in the Credit Agreement, and Imperial Bank
as Agent and as Issuing Bank(14)                 
|               |  |                                                                                                                                                                                                                     
|10.13          |  | Second Modification Agreement dated September 30, 2001, by and among Three-Five
Systems, Inc., its subsidiaries, the Banks named in the Credit Agreement, and
Comerica Bank-California as Agent and as Issuing Bank*
|               |  |                                                                                                                                                                                                                     
|10.14          |  | Third Modification Agreement dated January 31, 2002, by and among Three-Five
Systems,                                                                                                                               



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##### Table of Contents



|               |  |                                                                                                                                                                          
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Exhibits                                                                                                                                                                 
|               |  |                                                                                                                                                                          
|               |  |                                                                                                                                                                          
|               |  | Inc., its subsidiaries, the Banks named in the Credit Agreement, and
Comerica Bank-California as Agent and as Issuing Bank(15)                                           
|               |  |                                                                                                                                                                          
|10.15          |  | Technology License Agreement between Data International, Ltd. and TFS-DI dated
January 13, 2003*                                                                         
|               |  |                                                                                                                                                                          
|10.16          |  | Supply Agreement between Data International, Ltd. and TFS-DI dated January 13, 2003*                                                                                     
|               |  |                                                                                                                                                                          
|10.17          |  | Term Promissory Note dated January 13, 2003 executed by TFS-DI in favor of Data
International, Ltd.*                                                                     
|               |  |                                                                                                                                                                          
|21             |  | List of Subsidiaries*                                                                                                                                                    
|               |  |                                                                                                                                                                          
|23.1           |  | Consent of Deloitte & Touche LLP*                                                                                                                                        
|               |  |                                                                                                                                                                          
|23.2           |  | Notice Regarding Consent of Arthur Andersen LLP*                                                                                                                         
|               |  |                                                                                                                                                                          
|99.1           |  | Certification of the Chief Executive Officer of the Registrant, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002*
|               |  |                                                                                                                                                                          
|99.2           |  | Certification of the Chief Financial Officer of the Registrant, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002*



---

|*    |  | Filed herein.                                                                                                                                                                                    
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(1)  |  | Incorporated by reference to Exhibit 2 to the Registration Statement on
Form S-4 of TF Consolidation, Inc. (Registration No. 33-33944) as filed on
March 27, 1990.                               
|    
|(2)  |  | Incorporated by reference to Exhibit 3(a) to the Registrants Form 10-QSB
for the quarter ended March 31, 1994, as filed on or about May 12, 1994.                                               
|    
|(3)  |  | Incorporated by reference to Exhibit 3(b) to the Registration Statement
on Form S-3 (Registration No. 333-35788) as filed on April 27, 2000, as
amended by Form S-3/A as filed on May 5, 2000.   
|    
|(4)  |  | Incorporated by reference to Exhibit 3(d) to the Registrants Form 8-A as
filed on May 10, 2001.                                                                                                 
|    
|(5)  |  | Incorporated by reference to Exhibit 3(b) to the Registration Statement
on Form S-3 (Registration No. 333-84083) as filed on July 30, 1999, as
amended by Form S-3/A as filed on August 26, 1999.
|    
|(6)  |  | Incorporated by reference to Exhibit 4(b) to the Registrants Form 8-A as
filed on May 10, 2001.                                                                                                 
|    
|(7)  |  | Incorporated by reference to Exhibit 10(c) to the Registration Statement
on Form S-4 of TF Consolidation, Inc. (Registration No. 33-33944) as filed
on March 27, 1990.                           
|    
|(8)  |  | Incorporated by reference to Exhibit 10(o) to the Registrants Form 10-K
for the fiscal year ended December 31, 1996, as filed on March 14, 1997.                                                
|    
|(9)  |  | Incorporated by reference to Exhibit 10(x) to the Registrants Form 10-Q
for the quarter ended June 30, 2001, as filed on July 27, 2001.                                                         
|    
|(10) |  | Incorporated by reference to Exhibit 10.5(b) to the Registration
Statement on Form S-8 (Registration No. 333-59234) as filed on April 19,
2001.                                                  
|    
|(11) |  | Incorporated by reference to Exhibit 10(y) to the Registration Station
Statement on Form S-8 (Registration No. 333-50689) as filed on November 3,
2000.                                          
|    
|(12) |  | Incorporated by reference to Exhibit 10(z) to the Registration Statement
on Form S-8 (Registration No. 333-57933) as filed on June 26, 1998.                                                     
|    
|(13) |  | Incorporated by reference to Exhibit 10(aa) to the Registrants Form 10-Q
for the quarter ended June 30, 2000, as filed on July 27, 2000.                                                        
|    
|(14) |  | Incorporated by reference to Exhibit 10(cc) to the Registrants Form 10-K
for the fiscal year ended December 31, 2000, as filed on March 13, 2001.                                               
|    
|(15) |  | Incorporated by reference to Exhibit 10(cc) to the Registrants Form 10-Q
for the quarter ended March 31, 2002, as filed on April 19, 2002.